Measurement Error and Nonlinearity in the Earnings-Returns Relation

Measurement Error and Nonlinearity in the Earnings-Returns Relation There is a long history of research which examines the relation between unexpected earnings and unexpected returns on common stock. Early literature used simple linear regression models to describe this relation. Recently, a number of authors have proposed nonlinear models. These authors find that the earnings-returns relation is approximately linear for small changes but is 'S'-shaped globally. However, unexpected earnings are generated by the sum of a measurement error and a true earnings innovation, so the apparent nonlinearity could be an artifact of nonlinearity in the measurement errors. Using a research design that minimizes the presence of measurement errors, we provide evidence consistent with the hypothesis that measurement errors contribute to the nonlinearities in the earnings-returns relation. While we are not suggesting that the earnings-returns relation is linear, our evidence suggests that there is no advantage to using a nonlinear model for large firms that are widely followed by analysts. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Measurement Error and Nonlinearity in the Earnings-Returns Relation

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Publisher
Kluwer Academic Publishers
Copyright
Copyright © 1998 by 1998 Kluwer Academic Publishers
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1023/A:1008362715659
Publisher site
See Article on Publisher Site

References

  • Analysts' forecasts as proxies for investor beliefs in empirical research
    Abarbanell, J.S.; Lanen, W.N.; Verrechia, R.E.
  • Specification problems with information content of earnings: revisions and rationality of expectations and self-selection bias
    Abdel-khalik, A.R.
  • Nonlinearity in the returns-earnings relation: Tests of alternative specification and explanations
    Das, S.; Lev, B.
  • The cross section of expected returns
    Fama, E.F.; French, K.R.

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