Earnings Extrapolation And Predictable Stock Market Returns

96 Pages Posted: 13 Nov 2019 Last revised: 8 Dec 2021

See all articles by Hongye Guo

Hongye Guo

University of Pennsylvania

Date Written: November 16, 2019

Abstract

The U.S. stock market’s return during the first month of a quarter correlates strongly with returns in future months, but the correlation is negative (positive) if the future month is (is not) the first month of a quarter. These effects offset, leaving the market return with its weak unconditional predictive ability known to the literature. The pattern accords with a model in which investors extrapolate announced earnings to predict future earnings, not recognizing that earnings in the first month of a quarter are inherently less predictable than in other months. Survey data support this model, as does out-of-sample evidence across industries and international markets. These results seriously challenge the Efficient Market Hypothesis and advance a novel mechanism of expectation formation.

Keywords: Announcements, Stock Returns, Behavioral Finance

JEL Classification: G12, G14, G40

Suggested Citation

Guo, Hongye, Earnings Extrapolation And Predictable Stock Market Returns (November 16, 2019). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3480863 or http://dx.doi.org/10.2139/ssrn.3480863

Hongye Guo (Contact Author)

University of Pennsylvania ( email )

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