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Firm Profitability: Mean-Reverting or Random-Walk Behavior?

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  • Giorgio Canarella

    ()
    (Department of Finance, University of Nevada, Las Vegas)

  • Stephen M. Miller

    ()
    (Department of Economics, University of Nevada, Las Vegas)

  • Mahmoud M. Nourayi

    (Loyola Marymount University)

Abstract

We analyze the stochastic properties of three measures of profitability, return on assets (ROA), return on equity (ROE), and return on investment (ROI), using a balanced panel of US firms during the period 2001-2010. We employ a panel unit-root approach, which assists in identifying competitive outcomes versus situations that require regulatory intervention to achieve more competitive outcomes. Based upon conventional panel unit-root tests, we find substantial evidence supporting mean-reversion, which, in turn, lends support to the long-standing “competitive environment” hypothesis originally set forward by Mueller (1976). These results, however, prove contaminated by the assumption of cross-sectional independence. After controlling for cross-sectional dependence, we find that profitability persists indefinitely across some sectors in the US economy. These sectors experience extremely slow, or non-existent, mean-reversion.

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Bibliographic Info

Paper provided by University of Nevada, Las Vegas , Department of Economics in its series Working Papers with number 1202.

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Length: 32 pages
Date of creation: Apr 2012
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Handle: RePEc:nlv:wpaper:1202

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Keywords: Cross-sectional dependence; unit roots; panel data; hysteresis; firm profitability;

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