Earnings Volatility, Ambiguity, and Crisis-Period Stock Returns

36 Pages Posted: 11 Apr 2019

See all articles by Anwer S. Ahmed

Anwer S. Ahmed

Texas A&M University - Mays Business School

Andrew Stephen McMartin

University of Miami

Irfan Safdar

Widener University

Date Written: September 9, 2018


Financial crises are typically marked by substantial increases in ambiguity where prices appear to decouple from fundamentals. Consistent with ambiguity-based asset pricing theories, we find that ambiguity concerns are more severe for firms with higher pre-crisis earnings volatility, causing investors to demand a higher ambiguity premium for such firms. While there is no relation between earnings volatility and stock returns under normal conditions, there is a significant negative relation between crisis-period stock returns and prior earnings volatility. In other words, during economic turmoil, investors punish stocks whose past earnings volatility was higher despite that they do not perceive these stocks to be riskier under stable economic conditions. Our findings indicate that a firm’s past earnings volatility predicts its stock price performance during crisis periods. We also find that this relation is stronger in firms with low institutional ownership and low analyst-following, consistent with ambiguity concerns being more important for firms with a greater proportion of unsophisticated investors. Our results are robust to controlling for firm-level characteristics as well as industry-fixed effects. Our evidence suggests that earnings stability helps mitigate ambiguity-concerns during a financial crisis.

Keywords: earnings volatility, ambiguity, financial crisis, stock returns

JEL Classification: G01, G12, G11, G14, M41

Suggested Citation

Ahmed, Anwer S. and McMartin, Andrew Stephen and Safdar, Irfan, Earnings Volatility, Ambiguity, and Crisis-Period Stock Returns (September 9, 2018). University of Miami Business School Research Paper No. 3357232, Available at SSRN: https://ssrn.com/abstract=3357232 or http://dx.doi.org/10.2139/ssrn.3357232

Anwer S. Ahmed

Texas A&M University - Mays Business School ( email )

430 Wehner
College Station, TX 77843-4353
United States

Andrew Stephen McMartin

University of Miami ( email )

Coral Gables, FL 33146-6531
United States

Irfan Safdar (Contact Author)

Widener University ( email )

Chester, PA 19013
United States

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