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Using accounting earnings and aggregate economic indicators to estimate firm-level systematic risk

Author

Listed:
  • Ray Ball

    (University of Chicago)

  • Gil Sadka

    (University of Texas at Dallas)

  • Ayung Tseng

    (Indiana University)

Abstract

We revisit the literature on using accounting earnings to estimate firm-level systematic risk, using macroeconomic indicators rather than listed-firm indexes to measure aggregate risk. Conventional listed-firm indexes reflect an unrepresentative subset of aggregate assets and thus are expected to substantially mismeasure aggregate and systematic risk (J Financ Econ 4, 129–176, Roll 1977). That choice dictates using earnings rather than returns to measure firm-level outcomes. Earnings and macroeconomic indicators both are primarily realized annual outcomes and thus are better aligned in time than forward-looking returns for capturing the contemporaneous co-movements that underlie systematic risk. Our macroeconomic indicators are chosen to reflect shocks to aggregate supply and demand, providing a parsimonious model that incorporates the two fundamental determinants of aggregate risk. We find that firms’ earnings-based sensitivities (betas) to aggregate supply and demand shocks are negatively correlated and explain the cross-section of returns better than conventional “index” betas. The earnings-based sensitivities are correlated with firm characteristics employed in empirical asset pricing models and explain one quarter of the explanatory power of those characteristics.

Suggested Citation

  • Ray Ball & Gil Sadka & Ayung Tseng, 2022. "Using accounting earnings and aggregate economic indicators to estimate firm-level systematic risk," Review of Accounting Studies, Springer, vol. 27(2), pages 607-646, June.
  • Handle: RePEc:spr:reaccs:v:27:y:2022:i:2:d:10.1007_s11142-021-09594-9
    DOI: 10.1007/s11142-021-09594-9
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    More about this item

    Keywords

    Asset pricing; Earnings beta; Demand; Supply; Systematic risk;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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