Aggregate Earnings and Asset Prices


  • We gratefully acknowledge the comments of an anonymous referee, Torben Andersen, John Campbell, James Choi, Michael Cooper, Robert Dittmar, John Heaton, Ravi Jagannathan, Robert Korajczyk, Arvind Krishnamurthy, Marios Panayides, L̆ubos̆ Pástor, Richard Sloan, Abbie Smith (editor), Hongjun Yan, and workshop participants at University of Texas/Dallas, RSM Erasmus University, University of Amsterdam, Northwestern University/Kellogg, Columbia University, Yale University, Harvard Business School, University of Chicago, University of Utah, UC Berkeley, University of Pennsylvania/Wharton, UCLA, INSEAD, HEC Paris, London School of Economics, MIT, Texas Tech University, Barclays Global Investors, Goldman Sachs Asset Management, and State Street Global Advisors, as well as participants in the 2008 American Finance Association meeting, the 2008 American Accounting Association Annual Meeting, and the 2006 CRSP Forum. Any errors are our own.


A principal-components analysis demonstrates that common earnings factors explain a substantial portion of firm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the systematic components of earnings and returns is stable over time. We also show that the earnings factors are priced, in the sense that the sensitivities of securities' returns to the earnings factors explain a significant portion of the cross-sectional variation in returns, even controlling for return risk. This suggests earnings performance is an underlying source of priced risk. Our evidence that the information sets of returns and earnings are jointly determined implies cash flow risk and return risk are not fully separable, and raises the possibility that it is the common variation of earnings and returns that is priced.