The main purpose of this study is to examine the usefulness of pooled and firm-specific returns-earnings models in predicting price responses to future earnings news. The question addresses whether earnings response coefficients (ERCs) (i.e., slope coefficients obtained from regressions of market-adjusted returns on earnings surprises) are helpful in predicting price responses to future earnings surprises. In other words, are historical returns-earnings relations (as captured by ERCs) useful in predicting future returns-earnings relations? Surprisingly, we find that ERCs from firm-specific regressions provide less accurate predictions of price responses to future earnings surprises than ERCs from pooled regressions. In addition, out-of-sample predictions from actual-firm-specific regressions are no more accurate than those from pseudo-firm-specific regressions. This is despite the fact that our pseudo firms are created through random draws of returns-earnings data. Therefore, they have no economic characteristics that extend beyond the period over which the coefficients are estimated.
Review of Quantitative Finance and Accounting – Springer Journals
Published: Aug 14, 2010
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