Economic Persistence, Earnings Informativeness, and Stock Return Regularities

We propose a simple framework for understanding accounting-based stock return regularities. A firm’s accounting reports provide noisy information about hidden economic states that evolve according to a Markov process. In response to the accounting reports, a representative Bayesian investor forms beliefs about the underlying state and hence the value of the firm. For a population of such firms, the model provides predictions consistent with two sets of well-documented regularities: (i) the market reaction to an earnings announcement that ends a string of consecutive earnings increases and (ii) the return predictabilities based on accruals and book-tax differences. The model also yields novel cross-sectional predictions about the distinct roles of economic persistence and earnings informativeness. We confirm these predictions through empirical tests.

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Work Title Economic Persistence, Earnings Informativeness, and Stock Return Regularities
Access
Open Access
Creators
  1. Kai Du
  2. Steven J Huddart
Keyword
  1. Earnings informativeness
  2. Earnings strings
  3. Accruals anomaly
  4. Book-tax differences anomaly
  5. Economic persistence
License All rights reserved
Work Type Article
Publisher
  1. Review of Accounting Studies
Publication Date April 23, 2020
Publisher Identifier (DOI)
  1. https://doi.org/10.1007/s11142-020-09531-2
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Deposited July 07, 2020

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