On the Explanations for the Gross Profitability Effect: Insights from International Equity Markets

57 Pages Posted: 10 Feb 2014 Last revised: 6 Jan 2015

See all articles by Lei Sun

Lei Sun

School of Finance, Shanghai University of Finance and Economics

K.C. John Wei

Hong Kong Polytechnic University

Feixue Xie

University of Texas at El Paso - College of Business Administration - Department of Economics and Finance

Date Written: December 23, 2014

Abstract

This paper attempts to distinguish between rational and behavioral explanations for the gross profitability effect in the international setting. Using data from 41 countries over the period 1980-2010, we find that in most countries, firms with higher gross profitability subsequently experience higher stock returns. This positive effect of gross profitability on returns is significantly stronger in countries with low investment frictions, such as the U.S. However, the effect is not stronger in countries with severe limits-to-arbitrage, such as China. The results are consistent with the implications of investment-based asset pricing theory and not consistent with the behavioral mispricing explanation.

Keywords: Gross profitability, Cross-sectional returns, International equity markets, Q-theory, Mispricing

JEL Classification: G12, G14, G15

Suggested Citation

Sun, Lei and Wei, Kuo-Chiang (John) and Xie, Feixue, On the Explanations for the Gross Profitability Effect: Insights from International Equity Markets (December 23, 2014). Asian Finance Association (AsianFA) 2014 Conference Paper. Available at SSRN: https://ssrn.com/abstract=2393202 or http://dx.doi.org/10.2139/ssrn.2393202

Lei Sun (Contact Author)

School of Finance, Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Kuo-Chiang (John) Wei

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

Feixue Xie

University of Texas at El Paso - College of Business Administration - Department of Economics and Finance ( email )

500 W. University Ave.
El Paso, TX 79968
United States
915-747-7788 (Phone)
915-747-6268 (Fax)

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