Firm Profitability: Mean-Reverting or Random-Walk Behavior?

Giorgio Canarella, Stephen Miller and Mahmoud Nourayi
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Mahmoud Nourayi: Loyola Marymount University

No 1202, Working Papers from University of Nevada, Las Vegas , Department of Economics

Abstract: We analyze the stochastic properties of three measures of profitability, return on assets (ROA), return on equity (ROE), and return on investment (ROI), using a balanced panel of US firms during the period 2001-2010. We employ a panel unit-root approach, which assists in identifying competitive outcomes versus situations that require regulatory intervention to achieve more competitive outcomes. Based upon conventional panel unit-root tests, we find substantial evidence supporting mean-reversion, which, in turn, lends support to the long-standing “competitive environment” hypothesis originally set forward by Mueller (1976). These results, however, prove contaminated by the assumption of cross-sectional independence. After controlling for cross-sectional dependence, we find that profitability persists indefinitely across some sectors in the US economy. These sectors experience extremely slow, or non-existent, mean-reversion.

Keywords: Cross-sectional dependence; unit roots; panel data; hysteresis; firm profitability (search for similar items in EconPapers)
JEL-codes: C23 D22 L25 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2012-04
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Firm profitability: Mean-reverting or random-walk behavior? (2013)
Working Paper: Firm Profitability: Mean-Reverting or Random-Walk Behavior? (2012)
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