We develop an empirical method that allows us to evaluate the reliability of an expected return proxy via its association with realized returns even if realized returns are biased and noisy measures of expected returns. We use our approach to examine seven accounting‐based proxies that are imputed from prices and contemporaneous analysts' earnings forecasts. Our results suggest that, for the entire crosssection of firms, these proxies are unreliable. None of them has a positive association with realized returns, even after controlling for the bias and noise in realized returns attributable to contemporaneous information surprises. Moreover, the simplest proxy, which is based on the least reasonable assumptions, contains no more measurement error than the remaining proxies. These results remain even after we attempt to purge the proxies of their measurement error via the use of instrumental variables and grouping. We provide additional evidence, however, that demonstrates that some proxies are reliable when the consensus long‐term growth forecasts are low and/or when analysts' forecast accuracy is high.
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1 April 2005
Research Article|
April 01 2005
An Evaluation of Accounting‐Based Measures of Expected Returns
Peter D. Easton;
Peter D. Easton
aUniversity of Notre Dame.
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Steven J. Monahan
Steven J. Monahan
bINSEAD, Accounting and Control Area.
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Online ISSN: 1558-7967
Print ISSN: 0001-4826
American Accounting Association
2005
The Accounting Review (2005) 80 (2): 501–538.
Citation
Peter D. Easton, Steven J. Monahan; An Evaluation of Accounting‐Based Measures of Expected Returns. The Accounting Review 1 April 2005; 80 (2): 501–538. https://doi.org/10.2308/accr.2005.80.2.501
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