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

Giorgio Canarella, Stephen Miller () and Mahmoud M. Nourayi
Additional contact information
Mahmoud M. Nourayi: Loyola Marymount University

No 2012-05, Working papers from University of Connecticut, 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-section independence. After controlling for cross-section dependence, we find that profitability evolves as a non-stationary process in some sectors in the US economy. Our findings, especially taken as a whole, remain fairly robust to various assumptions regarding the underlying data generation process.

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)
New Economics Papers: this item is included in nep-bec
Date: 2012-02, Revised 2012-10
Note: Stephen M. Miller is corresponding author
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Published in Journal of Economics and Business, in press.

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https://media.economics.uconn.edu/working/2012-05R.pdf Full text (revised version) (application/pdf)
https://media.economics.uconn.edu/working/2012-05.pdf Full text (original version) (application/pdf)

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