Assessing the Structural Change in the Aggregate Earnings-Returns Relation

Abstract

We investigate the change in the aggregate earnings-returns relation from negative to positive. We first identify a gradual structural break around the second quarter of 1991. We then find evidence of three contributing factors to the change in the relation. They are: i) an increase in the relative importance of cash flow news in returns; ii) a decrease in the importance of discount rate news contained in unexpected aggregate earnings, which together increased the covariance between unexpected earnings and returns; and iii) a decrease in the persistence of expected aggregate earnings and expected returns which decreased the absolute value of the covariance between expected earnings and returns.

Keywords: Aggregate Earnings-Returns Relation, Structural Change, Discount Rate News, Cash Flow News, Persistence, Great Moderation

JEL Classification: E31, E32, G12, G14, M41