The impact of ambiguity on the value-relevance of earnings volatility: Evidence from the COVID-19 pandemic

Prior research states that during extreme uncertainties stock prices deviate from their fundamentals. This study examines the cross-section of share price returns during the COVID-19 and pre-COVID periods to determine how investors’ reaction to prior earnings volatility is affected by the COVID-19-induced ambiguity. The sample consists of 840 firms listed on the New York Stock Exchange (NYSE) from January 1, 2020 to May 31, 2021. Consistent with the notion that ambiguity-aversion is not a universal phenomenon, COVID-period stock returns exhibit a positive (β = 0.23) and statistically significant relationship with prior earnings volatility. In contrast, the stable period returns show a very weak, if any, correlation with prior earnings volatility. The positive relationship is more pronounced for firms that experience greater information asymmetry. When comparing the results with previous research, it appears that different crises evoke varied levels of ambiguity-aversion possibly because of the ways in which each crisis’s features and anticipated outcomes influence how the market reacts. Thus, before crafting responses to a crisis, policymakers and firms should thoroughly examine the crisis and identify the underlying causes, dynamics, and possible effects on decision-makers’ ambiguity-aversion behavior.