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On the Expected Earnings Hypothesis Explanation of the Aggregate Returns–Earnings Association Puzzle

Published online by Cambridge University Press:  18 October 2019

Warren Bailey Open the ORCID record for Warren Bailey [Opens in a new window]  and
Huiwen Lai Open the ORCID record for Huiwen Lai [Opens in a new window]
Warren Bailey
Affiliation:
Bailey, wbb1@cornell.edu, Cornell University Johnson Graduate School of Management and Fudan University Fanhai International School of Finance and China Institute of Economics and Finance
Huiwen Lai*
Affiliation:
Lai, afhlai@polyu.edu.hk, The Hong Kong Polytechnic University School of Accounting and Finance
*
Lai (corresponding author), afhlai@polyu.edu.hk
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Abstract

We provide strong support for the underappreciated expected earnings hypothesis of a negative correlation between aggregate stock returns and earnings. For 1970–2000, our powerful modeling strategy incorporating macroeconomic information reveals that aggregate returns are significantly and negatively correlated with expected aggregate earnings changes but uncorrelated with unexpected aggregate earnings changes. However, this negative correlation changes after 2000, perhaps from heightened volatility or accounting changes. We also show that underlying macroeconomic information explains the power of aggregate earnings to predict future gross domestic product growth.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 8 , December 2020 , pp. 2732 - 2763
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

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Footnotes

We thank Dichu Bao, Xiangpei Chen, Kim Sau Chung, Azhar Iqbal, Alon Kalay, Eric Ng, Gil Sadka, Jing Wang, Shuye Wang, and participants at the 2018 Hong Kong Economic Association and the 2018 Frontiers of Business Research in China International Symposium for their helpful comments and assistance. Lai gratefully acknowledges funding from the Research Grants Council of Hong Kong (PolyU 155062/15B).

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