Aggregate Earnings and Asset Prices



This paper applies a principal-components analysis to earnings and demonstrates that earnings factors explain a significant portion of firm-level earnings volatility, suggesting earnings shocks are not fully diversifiable.  The earnings factors are correlated with macroeconomic indicators such as Industrial Production and Real GDP, suggesting they reflect real business conditions. We also show that aggregate earnings are positively correlated with lagged aggregate returns (consistent with investors' foresight of future changes in earnings) and negatively correlated with contemporaneous aggregate returns (consistent with investors' demand of low rates of returns upon the expectation of high earnings). Moreover, the return sensitivities to lead earnings factors explain a significant portion of the cross-sectional variation of some asset-pricing anomalies. The findings enhance our understanding of the role of earnings in the economy and their effects on asset prices.
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Ingolf Dittmann