Aggregate Earnings and Asset Prices

41 Pages Posted: 24 Aug 2011 Last revised: 30 Aug 2011

Ray Ball

University of Chicago - Accounting

Gil Sadka

University of Texas at Dallas

Ronnie Sadka

Boston College - Carroll School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: July 27, 2009

Abstract

A principal-components analysis demonstrates that common earnings factors explain a substantial portion of …rm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the systematic components of earnings and returns is stable over time. We also show that the earnings factors are priced, in the sense that the sensitivities of securities' returns to the earnings factors explain a significant portion of the cross-sectional variation in returns, even controlling for return risk. This suggests earnings performance is an underlying source of priced risk. Our evidence that the information sets of returns and earnings are jointly determined implies cash-flow risk and return risk are not fully separable, and raises the possibility that it is the common variation of earnings and returns that is priced.

Keywords: Earnings factors, aggregate returns, SUE, market-to-book, systematic risk, cash-flow news, asset pricing

JEL Classification: E32, G12, G14, M41

Suggested Citation

Ball, Ray and Sadka, Gil and Sadka, Ronnie, Aggregate Earnings and Asset Prices (July 27, 2009). Columbia Business School Research Paper . Available at SSRN: https://ssrn.com/abstract=1915364 or http://dx.doi.org/10.2139/ssrn.1915364

Ray Ball

University of Chicago - Accounting ( email )

Gil Sadka (Contact Author)

University of Texas at Dallas ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

Ronnie Sadka

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

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