R-Squared and the Economy
51 Pages Posted: 26 Apr 2013 Last revised: 7 Jun 2013
Date Written: May 24, 2013
A literature review demonstrates credible evidence linking higher firm-specific stock return volatility to a more efficient stock market on one hand; and to higher firm-specific fundamentals volatility on the other. These results are reconciled if (1) market efficiency is interpreted as functionally efficiency, the allocation of capital to its best uses; (2) capital’s best use is often financing Schumpeterian creative destruction, which magnifies the gap between creative winners and destroyed losers, thus magnifying firm-specific fundamentals variation; (3) initially impecunious innovators require functionally efficient markets to finance their innovations. Informed arbitrage, disclosure quality, and insider trading regulations can contribute to functional efficiency, and thus help sustained ongoing creative destruction. A range of seeming inconsistencies in the empirical literature are reconciled if information has high fixed costs, driving a wedge between functional efficiency and traditional finance concepts of information efficiency. This wedge implies positive and negative feedback loops, whereby creative destruction might either enhance or diminish functional efficiency, thereby either accelerating or retarding its subsequent pace. Institutional differences across economies and over time potentially that affect which feedback predominates merit public policy attention.
Keywords: Stock Returns Co-Movement, Synchronicity, Market Efficiency, Creative Destruction, Economic Development
JEL Classification: F3, G14, G3, O16, O3
Suggested Citation: Suggested Citation