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

  • 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)

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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File URL: http://web.unlv.edu/projects/RePEc/pdf/1202.pdf
File Function: First version, 2012
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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
Date of revision:
Handle: RePEc:nlv:wpaper:1202
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Web page: http://business.unlv.edu/econ/

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