Predicting Firm Profits: From Fama-MacBeth to Gradient Boosting
64 Pages Posted: 10 Sep 2021
Date Written: September 7, 2021
This paper studies the predictability of firm profits using Fama-MacBeth regressions and gradient boosting. Gradient boosting can use more relevant factors and it predicts better. Profits are more predictable at firms that are large, investment grade, low R&D, low market-to-book, low cash flow volatility. Effects on financing decisions, and cross-section of stock returns are studied. During recessions profits are less predictable - particularly non-investment grade firms. Both algorithms produce estimates like those interpreted in the literature as evidence of excessive human optimism during booms and excessive pessimism during recessions.
Keywords: Expected profit, Fama-MacBeth, gradient boosting, firm financing decisions, cross-section of stock returns, behavioral finance
JEL Classification: G17, G32, G40
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