TITLE

An Evaluation of Accounting-Based Measures of Expected Returns

AUTHOR(S)
Easton, Peter D.; Monahan, Steven J.
PUB. DATE
April 2005
SOURCE
Accounting Review;Apr2005, Vol. 80 Issue 2, p501
SOURCE TYPE
Academic Journal
DOC. TYPE
Article
ABSTRACT
We develop an empirical method that allows us to evaluate the reliability of an expected return proxy via its association with realized returns even if realized returns are biased and noisy measures of expected returns. We use our approach to examine seven accounting-based proxies that are imputed from prices and contemporaneous analysts' earnings forecasts. Our results suggest that, for the entire cross-section of firms, these proxies are unreliable. None of them has a positive association with realized returns, even after controlling for the bias and noise in realized returns attributable to contemporaneous information surprises. Moreover, the simplest proxy, which is based on the least reasonable assumptions, contains no more measurement error than the remaining proxies. These results remain even after we attempt to purge the proxies of their measurement error via the use of instrumental variables and grouping. We provide additional evidence, however, that demonstrates that some proxies are reliable when the consensus long-term growth forecasts are low and/or when analysts' forecast accuracy is high.
ACCESSION #
16778839

 

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