Illiquidity and the Measurement of Stock Price Synchronicity

51 Pages Posted: 7 Mar 2014 Last revised: 28 Dec 2017

Joachim Gassen

Humboldt University of Berlin - School of Business and Economics; Humboldt University of Berlin - Center for Applied Statistics and Economics (CASE)

Hollis Ashbaugh Skaife

Graduate School of Management, UC-Davis

David Veenman

University of Amsterdam - Amsterdam Business School (ABS)

Multiple version iconThere are 2 versions of this paper

Date Written: December 2017

Abstract

Research on stock price synchronicity can provide insights into the effects of financial reporting and disclosure on the efficiency with which prices incorporate firm-specific information. This paper demonstrates that measures of stock price synchronicity based on market model R2s are biased downwards by stock illiquidity, and that traditional remedies used to correct beta for the effects of illiquidity are not effective at correcting R2. This explains why prior research finds low R2 to be associated with relatively weaker information environments, counter to the assumption that low R2 represents more informative stock prices. We show how the predictable bias in R2 can lead to both type I and type II errors when illiquidity is not controlled for and propose a simple adjustment that purges illiquidity effects from synchronicity measures. Lastly, we introduce a method for testing changes in synchronicity around an information event that circumvents the estimation of a market model and the resulting illiquidity-bias in R2.

Keywords: Stock price synchronicity; Stock illiquidity; Disclosure; Transparency; Zero returns; Price informativeness; Management forecasts; IFRS

JEL Classification: G12, G14, G15, M40, N20

Suggested Citation

Gassen, Joachim and Skaife, Hollis Ashbaugh and Veenman, David, Illiquidity and the Measurement of Stock Price Synchronicity (December 2017). Available at SSRN: https://ssrn.com/abstract=2405465 or http://dx.doi.org/10.2139/ssrn.2405465

Joachim Gassen

Humboldt University of Berlin - School of Business and Economics ( email )

Spandauer Str. 1
Berlin, D-10099
Germany
+49 30 2093 5764 (Phone)
+49 30 2093 5670 (Fax)

Humboldt University of Berlin - Center for Applied Statistics and Economics (CASE) ( email )

Spandauer Strasse 1
Berlin, D-10178
Germany

Hollis Ashbaugh Skaife

Graduate School of Management, UC-Davis ( email )

Graduate School of Management
1 Shields Ave
Davis, CA 95616
United States

David Veenman (Contact Author)

University of Amsterdam - Amsterdam Business School (ABS) ( email )

Roetersstraat 18
Amsterdam, 1018WB
Netherlands

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