The Profitability Premium: Macroeconomic Risks or Expectation Errors?

53 Pages Posted: 12 Aug 2014 Last revised: 14 Mar 2016

See all articles by FY Eric Lam

FY Eric Lam

Hong Kong Monetary Authority - Hong Kong Institute for Monetary Research (HKIMR)

Shujing Wang

Tongji University

K.C. John Wei

Hong Kong Polytechnic University

Multiple version iconThere are 2 versions of this paper

Date Written: March 2016

Abstract

Macroeconomic risks only partially capture the profitability premium, while adding a misvaluation factor based on investor sentiment helps explain a substantial amount of it. The profitability premium mainly exists in firms whose market valuations are inconsistent with their profitability and therefore subject to ex-ante expectation errors during high sentiment periods. Direct evidence shows that firms with high profitability but low market valuation have significantly higher abnormal earnings announcement returns, analyst earnings forecast errors and forecast revisions than firms with low profitability but high market valuation. Return decomposition further confirms that the profitability premium is driven by the unexpected cash-flow component.

Keywords: Profitability premium, Macroeconomic Risks, Expectation errors, Investor sentiment

JEL Classification: G14, G31, G32, M41, M42

Suggested Citation

Lam, Full Yet Eric Campbell and Wang, Shujing and Wei, Kuo-Chiang (John), The Profitability Premium: Macroeconomic Risks or Expectation Errors? (March 2016). Available at SSRN: https://ssrn.com/abstract=2479232 or http://dx.doi.org/10.2139/ssrn.2479232

Full Yet Eric Campbell Lam (Contact Author)

Hong Kong Monetary Authority - Hong Kong Institute for Monetary Research (HKIMR) ( email )

55/F, Two International Finance Centre,
8 Finance Street, Central
Hong Kong
China

Shujing Wang

Tongji University ( email )

Shanghai
China

Kuo-Chiang (John) Wei

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

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