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Title: Studies on the rationality of earnings expectations and the risk in earnings
Author: Konstantinidi, Theodosia
Awarding Body: Lancaster University
Current Institution: Lancaster University
Date of Award: 2011
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This thesis consists of three self-contained studies, one study on the mispricing of accruals and cash flows and two studies on accounting-based measures of risk. In the first study. we use insights from the literature on accounting conservatism and the literature on econometrics to improve previous applications of the Mishkin (1983) test (MT). a test of rational expectations, in accounting. We find that the specification of linear accrual forecasting models in the MT ignores the asymmetric timeliness in gain and loss recognition and understates the ability of accruals to predict future earnings components. When we incorporate timely loss recognition in the MT, we provide evidence that investors rationally anticipate the lower persistence of accruals in years of economic losses. A re-specification of the MT shows that investors respond differently to accrual and cash flow surprises, which is inconsistent with investors fixating on earnings. Furthermore, clustering the standard errors in the MT by both the firm and the year dimension significantly alters market efficiency inferences and the results no longer support the mispricing of accruals and cash flows. In the second study, we build on the literature on fundamental risk and propose two new accounting-related risk measures - the systematic risk and the total risk in analysts' earnings forecasts. We find that both risk measures are significant determinants of the implied risk premium, beyond the risk in annual reported earnings and the Fama and French (1993) factors - market beta, book-to-market and size. Furthermore, we show that our risk measures are related to the risk captured by book-ta-market and that they explain largely the higher expected returns of high book-ta-market stocks relative to low book-ta-market stocks. Our study demonstrates the usefulness of analysts' earnings forecasts in assessing equity risk and allows the estimation of fundamental risk when the time-series of annual reported earnings is limited. In the third study, we focus on forecasting the shape of the distribution of future earnings, aiming at predicting the risk associated with future earnings outcomes. First, we show that current earnings changes are a significant determinant of the shape of the distribution of future earnings changes and hence, of the risk in future earnings. Second, we find that accruals are incrementally informative in predicting the distribution of future earnings changes, significantly enhancing in-sample and out-of-sample forecasting performance. Third, pricing tests show that the expected earnings of firms with more extreme predicted losses and higher predicted earnings uncertainty, defined as the distance between predicted extreme quantiles, have lower valuation multiples. Our results suggest that fundamentals-based risk forecasts are priced by the stock market.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available