Information Efficiency and Firm-Specific Return Variation
Patrick J. Kelly
New Economic School, Moscow
March 15, 2007
This paper examines whether private information is the primary source of poor market model fit as posited by Morck, Yeung, and Yu (2000), which proposes R2 as an inverse measure of "price informativeness." We show that low R2 stocks have a poor information environment: high information costs and greater impediments to informed trade. Using microstructure measures of the probability of private information events, we find that low R2 stocks have fewer expected informed trades and are subject to greater asymmetric information risk, while having a lower likelihood of a private information event. We decompose idiosyncratic volatility to reveal that each private information event causes more volatility and is relatively more valuable for low R2 stocks than for high. However, cumulatively, the level of firm-specific volatility occurring on days with and without privately informed trade is similar, suggesting that differences in R2 do not translate to differences in information efficiency.
Number of Pages in PDF File: 52
Keywords: Market efficiency, idiosyncratic volatility, information efficiency, Synchronicity
JEL Classification: G12, G14working papers series
Date posted: March 23, 2007
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