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

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Author Info

  • Giorgio Canarella

    (California State University, Los Angeles and University of Nevada, Las Vegas)

  • Stephen M. Miller

    (University of Nevada, Las Vegas and University of Connecticut)

  • 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-section independence. After controlling for cross-section dependence, we find that profitability evolves as a non-stationary process in some sectors in the US economy. Our findings, especially taken as a whole, remain fairly robust to various assumptions regarding the underlying data generation process.

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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2012-05.

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Length: 45 pages
Date of creation: Feb 2012
Date of revision: Oct 2012
Publication status: Published in Journal of Economics and Business, in press.
Handle: RePEc:uct:uconnp:2012-05

Note: Stephen M. Miller is corresponding author
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Postal: University of Connecticut 341 Mansfield Road, Unit 1063 Storrs, CT 06269-1063
Phone: (860) 486-4889
Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/
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Keywords: Cross-sectional dependence; unit roots; panel data; hysteresis; firm profitability;

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References

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