Time-varying risk, mispricing attributes, and the accrual premium

We examine the mispricing attributes of the accrual effect in the presence of time-varying common risk factors, which are not independent of aggregate economic conditions. We find that the persistence of unconditional abnormal returns for accrual-based portfolios is not independent of firm-level characteristics such as size and book-to-market ratio (BE/ME). However, after adjusting for time-varying risk measures, the premiums associated with accruals and firm fundamentals are distinct from one another. The empirical evidence shows that a long-short hedge portfolio based on accruals and BE/ME generates significant abnormal returns even in the presence of time-varying risk. Taken together, our time-series and cross-sectional evidence strengthens the assertion that the well-known accrual effect is significantly associated with high-BE/ME value firms that tend to be low-investment firms. The fact that time-varying risk adds to the description of average returns of accrual-sorted portfolios and corroborates the presence of the accrual premium contributes significantly to the literature.