Understanding Stock Price Volatility: The Role of Earnings



This article is corrected by:

  1. Errata: Erratum Volume 45, Issue 4, 883–884, Article first published online: 17 July 2007

  • I would like to thank an anonymous referee, Ray Ball, Philip Berger, John Cochrane, Daniel Cohen, Wendy Heltzer, Richard Leftwich, Stephen Penman, Efraim Sadka, Ronnie Sadka, Douglas Skinner, Helen Wang, Kendrew Witt, and workshop participants at the University of Chicago, UCLA, University of Pennsylvania, MIT, New York University, Columbia University, London Business School, University of California Berkeley, University of Washington, Northwestern University, University of Illinois at Urbana-Champaign, and Dartmouth College for comments and suggestions. Any errors are my own. I gratefully acknowledge financial support from Columbia University, University of Chicago, and the Ernie Wish fellowship.


In an efficient capital market, asset prices vary when investors change their expectations about cash flows, discount rates, or both. Using dividends to measure cash flows, previous research shows that the aggregate dividend-price ratio varies due to changes in expected discount rates (returns) rather than expected cash flows. In contrast, using accounting earnings instead of dividends as a measure of cash flows, this paper shows that as much as 70% of the variation in the dividend-price ratio can be explained by changes in expected earnings. Moreover, the paper documents a significant negative correlation between expected returns and expected earnings, suggesting that variations in a common factor to both may generate significant price volatility. The results are consistent with the dividend-policy irrelevance hypothesis.