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Asset returns with earnings management

  • Bo Sun
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The paper investigates stock return dynamics in an environment where executives have an incentive to maximize their compensation by artificially inflating earnings. A principal-agent model with financial reporting and managerial effort is embedded in a Lucas asset-pricing model with periodic revelations of the firm's underlying profitability. The return process generated from the model is consistent with a range of financial anomalies observed in the return data: volatility clustering, asymmetric volatility, and increased idiosyncratic volatility. The calibration results further indicate that earnings management by individual firms does not only deliver the observed features in their own stocks, but can also be strong enough to generate market-wide patterns.

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File URL: http://www.federalreserve.gov/pubs/ifdp/2009/988/default.htm
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File URL: http://www.federalreserve.gov/pubs/ifdp/2009/988/ifdp988.pdf
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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 988.

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Date of creation: 2009
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Handle: RePEc:fip:fedgif:988
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  1. Schwert, C.W., 1989. "Margin Requirements And Stock Volatility," Papers t6, Columbia - Center for Futures Markets.
  2. Hentschel, Ludger & Campbell, John, 1992. "No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns," Scholarly Articles 3220232, Harvard University Department of Economics.
  3. Illoong Kwon & Eunjung Yeo, 2008. "Overstatement and Rational Market Expectation," Discussion Papers 08-07, University at Albany, SUNY, Department of Economics.
  4. Hamao, Yasushi & Masulis, Ronald W & Ng, Victor, 1990. "Correlations in Price Changes and Volatility across International Stock Markets," Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 281-307.
  5. Jiang Wang, 1993. "A Model of Intertemporal Asset Prices Under Asymmetric Information," Review of Economic Studies, Oxford University Press, vol. 60(2), pages 249-282.
  6. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
  7. Benoit Mandelbrot, 1963. "The Variation of Certain Speculative Prices," The Journal of Business, University of Chicago Press, vol. 36, pages 394.
  8. Jamsheed Shorish & Stephen E. Spear, 2005. "Shaking the tree: an agency-theoretic model of asset pricing," Annals of Finance, Springer, vol. 1(1), pages 51-72, 01.
  9. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  10. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
  11. Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Mark, 1998. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good To Be True?," NBER Working Papers 6354, National Bureau of Economic Research, Inc.
  12. Gary Gorton & Ping He, 2006. "Agency-Based Asset Pricing," NBER Working Papers 12084, National Bureau of Economic Research, Inc.
  13. John Y. Campbell & Martin Lettau & Burton G. Malkiel & Yexiao Xu, 2000. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," NBER Working Papers 7590, National Bureau of Economic Research, Inc.
  14. Anil Arya & Shyam Sunder & Jonathan Glover, 2002. "Are Unmanaged Earnings Always Better for Shareholders?," Yale School of Management Working Papers ysm295, Yale School of Management, revised 01 Feb 2003.
  15. Christie, Andrew A., 1982. "The stochastic behavior of common stock variances : Value, leverage and interest rate effects," Journal of Financial Economics, Elsevier, vol. 10(4), pages 407-432, December.
  16. Detemple, Jerome B, 1986. " Asset Pricing in a Production Economy with Incomplete Information," Journal of Finance, American Finance Association, vol. 41(2), pages 383-91, June.
  17. Lacker, Jeffrey M. & Levy, Robert J. & Weinberg, John A., 1990. "Incentive compatible financial contracts, asset prices, and the value of control," Journal of Financial Intermediation, Elsevier, vol. 1(1), pages 31-56, March.
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