Ambiguity, Earnings Surprises, and Asset Prices

Ambiguity impedes diversification. Hence, cash flow news will affect aggregate returns when ambiguity of cash flow news is high. We provide supporting evidence using data of this. In our sample, we find strong empirical evidence that the firm-level return-earnings relation is monotonically increasing with the degree of firm-level ambiguity. Increase in market-level ambiguity significantly decreases the individual earnings response coefficient of high firm-level ambiguity firms and increases the individual earnings response coefficient of low firm-level ambiguity firms. When we sort stocks based on the firm-level ambiguity and aggregate them into portfolios, we find that the aggregate earnings response coefficient increases with the degree of firm-level ambiguity. The market-wide ambiguity significantly decreases the earnings response coefficient of the portfolio of low ambiguity firms. Once the ambiguity measures are included into the regression, we get negative and statistically significant earnings response coefficient for low ambiguity firms during the period of high market ambiguity.