Profits: Mean Diverting with High Volatility

John Silvia, Azhar Iqbal

Abstract


Even though the behavior of the U.S. profit growth varies over the economic cycle that variation itself drives investor behavior and asset prices. We raise three fundamental questions which are; first, does profit growth over time exhibit a mean-reverting behavior? Second, how volatile are profits and does this volatility obscure the message of profit growth? Finally, do profit growth rates vary between decades/ sub-samples?

Our efforts suggest that since 1970 the mean and standard deviation of profit growth had actually been decreasing up until 1990s. For the most recent (2000-08) period, the profit growth shows an up-tick in both the mean and the standard deviation. For the entire period, 1970-2008, we find that the trend coefficient is statistically insignificant.

We apply the traditional unit root tests, efficient unit root tests, and unit root tests with structural break on the profits series. In addition, we follow Hamilton’s approach and apply an ARCH approach on the profits series.

Our empirical findings are consistent with the Schumpeter’s view, mean-diversion with a possibility of deviation from long-run trend growth. In addition to the factors introduced by Schumpeter there may be some exogenous shocks which could alter the long-run path of the profits.


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International Journal of Economics and Finance  ISSN  1916-971X (Print) ISSN  1916-9728 (Online)

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