In this paper we investigate the impact of fraud risk -- measured by the probability for earnings overstatements -- on a firms future stock market performance. Based on an out-of-sample estimation of individual firms' fraud risk, we find that stocks with higher fraud risk earn significantly lower stock market returns. A trading strategy going long in stocks of firms with low fraud risk and short in stocks of firms with high fraud risk delivers a statistically significant alpha of more than 10% per year. This result is robust to controlling for differences in firms' liquidity, downside risk, or investor preferences. Our results suggest that the market does not efficiently price corporate fraud risk. Limits of arbitrage do not explain our results. Furthermore, abnormal returns are higher after periods of high sentiment, suggesting that the return patterns documented here constitute an anomaly.
Dieser Eintrag ist Teil der Universitätsbibliographie.
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