Ambiguity, Earnings Surprises and Stock Returns

This project studies the effect of ambiguity on the return-earnings relations at both firm- and aggregate-level. We aim to find that individual earnings response coefficient increases with ambiguity about stock-specific cash flow news. When stocks are aggregated into portfolios, there is a positive contemporaneous relationship between aggregate returns and earnings growth for portfolios with high firm-level ambiguity. We argue that these results are consistent with the notion that ambiguity impedes diversification of firm-specific news, thereby yielding a significant cash flow news impact on the aggregate returns. High market-level ambiguity about discount rate news further amplifies those effects. These findings suggest that ambiguity should be taken into account when examining the incorporation of information into stock price, particularly for the aggregate level.