Does Volatility Improve UK Earnings Forecasts?

<jats:p><jats:bold>Abstract: </jats:bold> We investigate the relation between UK accounting earnings volatility and the level of future earnings using a unique sample comprising some 10,480 firm‐year observations for 1,481 non‐financial firms over the 1985–2003 period. The findings confirm the in‐sample result of an inverse volatility‐earnings relation only for the 1998–2003 sub‐period and for the most profitable firms. The out‐of‐sample forecast accuracy for the top earnings quintile improves when volatility is added as a regressor to a model including only lagged earnings. The findings are consistent with the over‐investment hypothesis and the view that the earnings of the most volatile firms tend to mean revert more rapidly.</jats:p>