The Profitability Premium: Macroeconomic Risks or Expectation Errors?

Financial Management Association (FMA) 2014 conference

53 Pages Posted: 3 Feb 2016 Last revised: 5 Mar 2020

See all articles by FY Eric C Lam

FY Eric C Lam

Hong Kong Institute for Monetary and Financial Research

Shujing Wang

Tongji University

K. C. John Wei

Hong Kong University of Science & Technology (HKUST)

Multiple version iconThere are 2 versions of this paper

Date Written: January 1, 2015

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, K.C. John, The Profitability Premium: Macroeconomic Risks or Expectation Errors? (January 1, 2015). Financial Management Association (FMA) 2014 conference, Available at SSRN: https://ssrn.com/abstract=2726027 or http://dx.doi.org/10.2139/ssrn.2726027

Full Yet Eric Campbell Lam

Hong Kong Institute for Monetary and Financial Research ( email )

Hong Kong

Shujing Wang (Contact Author)

Tongji University ( email )

Shanghai
China

K.C. John Wei

Hong Kong University of Science & Technology (HKUST)

Clearwater Bay
Kowloon, 999999
Hong Kong

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