Aggregate Earnings and Market Returns: International Evidence

Abstract

Kothari, Lewellen, and Warner (2006) document that aggregate earnings changes in the United States are negatively related to contemporaneous market returns. In this study we show that this negative aggregate earnings-returns relation is unique to the United States. In 28 non-U.S. markets, aggregate earnings changes are positively associated with contemporaneous market returns. Further evidence shows that the aggregate earnings-returns relation becomes less positive in countries with more transparent financial disclosure that helps investors forecast earnings more precisely. Our result supports Sadka and Sadka's (2009) argument that predictability of aggregate earnings leads to the negative relation between aggregate earnings and market returns in the United States.

The Impacts of the Market-Wide Cost of Capital on Aggregate Earnings-Returns Relation - Evidence from Japan

“…Thus, this study contributes to expanding the external validity of the hypothesis. As the second contribution, our results suggest the importance of focusing on an argument regarding investors' risk-avoidance in the SS hypothesis, although prior studies supporting the SS hypothesis mainly focus on the other argument regarding the higher predictability of aggregate earnings (Ball et al 2009;He and Hu 2014). Our results suggest that showing predictability is insufficient to support the SS hypothesis.…”

“…They show that when they control for federal fund rate news, the aggregate earnings-returns relation changes from significantly negative to insignificant. To the contrary, He and Hu (2014) report that, though aggregate earnings changes are positively correlated with contemporaneous changes in interest rates and inflation, the aggregate earnings-returns relation does not change even after controlling for these variables outside the U.S. market. In summary, these studies support the validity of the KLW hypothesis in the U.S. market, while it is not proven outside of the U.S. market.…”

“…Although several prior U.S. studies empirically support this hypothesis (e.g., Patatoukas 2014), the validity of this hypothesis in the Japanese market has not been sufficiently investigated. He and Hu (2014) is the only study that investigates whether some components of the marketwide cost of capital affect the aggregate earnings-returns relation outside the U.S. market. They reveal that the aggregate earnings-returns relation does not change after controlling for contemporaneous changes in interest rates and inflation in non-U.S. markets, which differs from the U.S. evidence (Uysal 2010;Gallo et al 2016).…”

“…However, it is still not clear whether the market-wide cost of capital cancels out the positive aggregate earnings-returns relation in the Japanese stock market for three reasons. First, He and Hu (2014) do not consider the market risk premium in their analysis. In other words, they do not control for all the necessary variables in their regression model.…”

“…Additionally, our results have an implication for future international research. He and Hu (2014) report that interest rates and inflation do not affect the aggregate earnings-returns relation Market-Wide Cost of Capital Impacts on the Aggregate Earnings-Returns Relation: Evidence from Japan outside the U.S. market. However, they do not consider the market risk premium.…”