Future Earnings Growth Volatility and the Value Premium

The value premium is well established in empirical asset pricing, but to date there is little understanding as to its fundamental drivers. We use a stochastic earnings valuation model to establish a direct link between the volatility of future earnings growth and firm value. We illustrate that risky earnings growth affects growth and value firms differently. We provide empirical evidence that the volatility of future earnings growth is a significant determinant of the value premium. Using data on individual firms and characteristic-sorted test portfolios, we also find that earnings growth volatility is significant in explaining the cross-sectional variation of stock returns. Our findings imply that the value premium is the rational consequence of accounting for risky earnings growth in the firm valuation process.

Award for the Best Cornell Quarterly Article in 2002

[Excerpt] I am pleased to announce that the following article has been named Cornell Quarterly article of the year for 2002 (it appeared in the August 2002 issue): "Assessing the Profitability of Premium Players," by Anthony Lucas, Jim Kilby, and Jocelina Santos