Working Paper: CEPR ID: DP12597
Authors: Martin Schmalz; Sergey Zhuk
Abstract: When Bayesian risk-averse investors are uncertain about their assets'cash flows' exposure to systematic risk, stock prices react more tonews in downturns than in upturns, implying higher volatility in downturnsand negatively skewed returns. The reason is that, in good times,less desirable assets with low average cash flows and high loadingon market risk perform similar to more desirable assets with highaverage cash flows and low market risk, rendering them difficult todistinguish. However, their relative fundamental performance divergesin downturns, enabling better inference. Consistent with these predictions,stocks' reaction to earnings news is up to 70% stronger in downturnsthan in upturns.
Keywords: Bayesian Learning; Earnings Response; Business Cycle; Asymmetry
JEL Codes: G00; G10; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| economic state (downturn) (E32) | stock prices (G12) |
| economic state (downturn) (E32) | earnings response coefficients (ERCs) (C51) |
| earnings response coefficients (ERCs) (C51) | stock price reactions to news (G14) |
| economic state (downturn) (E32) | divergence of asset performance (G19) |
| divergence of asset performance (G19) | investor perception (G24) |
| economic state (downturn) (E32) | negatively skewed return distributions (C46) |