Investor Uncertainty and the Earnings-Return Relation

support. I also benefited from comments by Tina Xu and other workshop participants at the University of Missouri-Columbia. I also wish to thank Ron Howren for his technical support including programming and databases. I gratefully acknowledge I/B/E/S International, Inc. for providing data on earnings forecasts and other data. All errors are my own. Investor Uncertainty and the Earnings-Return Relation This paper examines the role of investor uncertainty on the earnings-return relation. In the absence of perfect knowledge about the true state of the economy, investors form beliefs about this state variable. Recent theory proposes that uncertainty in their belief about the true state of the economy varies across time and influences investors ’ response to information. Specifically, theory asserts that investors ’ response to information will be more muted during times of investor uncertainty. This study empirically evaluates this prediction. In particular, I examine whether changes in expectations of future earnings are more heavily weighted in current stock returns when investor uncertainty is low. The theory also anticipates that unexpected current earnings will be more heavily weighted when investor uncertainty is low. The evidence supports both predictions