DP12528 | Sticky Expectations and the Profi tability Anomaly

Publication Date

12/21/2017

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Abstract

We propose a theory of one of the most economically signifi cant stock market anomalies, i.e. the "pro fitability" anomaly. In our model, investors forecast future profi ts using a signal and sticky belief dynamics. In this model, past profi ts forecast future returns (the pro fitability anomaly). Using analyst forecast data, we measure expectation stickiness at the fi rm level and find strong support for three additional predictions of the model: (1) analysts are on average too pessimistic regarding the future pro fits of high pro t rms, (2) the pro fitability anomaly is stronger for stocks which are followed by stickier analysts, and (3) it is also stronger for stocks with more persistent pro fits.