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

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  • Bailey, Warren
  • Lai, Huiwen

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.

Suggested Citation

  • Bailey, Warren & Lai, Huiwen, 2020. "On the Expected Earnings Hypothesis Explanation of the Aggregate Returns–Earnings Association Puzzle," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 55(8), pages 2732-2763, December.
    • Handle: RePEc:cup:jfinqa:v:55:y:2020:i:8:p:2732-2763_11
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    Cited by:

    1. Lijuan Zhang & Neil Fargher, 2022. "Aggregate accounting earnings, special items and growth in gross domestic product: evidence from Australia," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 62(2), pages 2467-2496, June.

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