Assessing the Price–Earnings Relation via Machine Learning

77 Pages Posted: 14 Apr 2021

See all articles by Catalin Starica

Catalin Starica

University of Neuchatel - Faculty of Economics and Business; Economics; Economics

Jan Peter Marton

University of Gothenburg

Date Written: October 10, 2019

Abstract

The relation between stock prices and accounting earnings has been a central theme in accounting research for more than half a century. By almost exclusively emphasizing a lin- ear, parametric approach, the literature has been unable to convincingly overcome a number of modeling issues, including the effects of non-linearity and lack of fit.

We show that a non-linear, non-parametric approach based on recent advances in statistics and machine learning successfully addresses these modeling issues. Our methodology is validated in three ways: 1) residuals meet the orthogonality property, i.e., the estimated relation fits, 2) the firm-specific dependence of price on earnings agrees with theoretical predictions in the literature, and 3) our empirical earnings response coefficients yield reasonable cost of capital estimates.

Keywords: earnings, price–earnings relation, earnings response coefficient, price level regression, machine learning, non-linear association, non-parametric regression

JEL Classification: G10, G30, M41

Suggested Citation

Starica, Catalin and Marton, Jan Peter, Assessing the Price–Earnings Relation via Machine Learning (October 10, 2019). Available at SSRN: https://ssrn.com/abstract=3813048 or http://dx.doi.org/10.2139/ssrn.3813048

Catalin Starica (Contact Author)

University of Neuchatel - Faculty of Economics and Business ( email )

A.-L. Breguet 2
CH-2000 Neuchatel
Switzerland

Economics ( email )

Box 605
SE 405 30 Goeteborg
Sweden

HOME PAGE: http://www.math.chalmers.se\~starica

Economics ( email )

Box 640
Vasagatan 1 E-building floor 5 & 6
Göteborg, 40530
Sweden

HOME PAGE: http://www.math.chalmers.se\~starica

Jan Peter Marton

University of Gothenburg ( email )

P.O. Box 610
Goteborg, 40530
Sweden

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