Illiquidity and the Measurement of Stock Price Synchronicity

Posted: 21 Jun 2019

See all articles by Joachim Gassen

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 3 versions of this paper

Date Written: April 16, 2019

Abstract

This paper demonstrates that measures of stock price synchronicity based on market model R2s are predictably biased downwards as a result of stock illiquidity, and that previously‐employed remedies to correct market model betas for measurement bias do not fix R2. Using a large international sample of firm‐years, we find strong negative and nonlinear relations between illiquidity and R2 across countries, across firms, and over time. Because variables of interest frequently relate to illiquidity as well, we illustrate the consequences of not controlling for illiquidity in synchronicity research. More generally, we demonstrate the importance of using nonlinear control variable methods. Overall, we conclude that the illiquidity‐driven measurement bias in R2 provides an explanation for why prior research finds low‐R2 firms to have weak information environments, and suggest future research carefully evaluate the sensitivity of its results to nonlinear controls for illiquidity.

Keywords: Return Synchronicity, Comovement, Price Informativeness, Illiquidity, Zero Returns, Corporate Transparency, Sell-Side Analysts, Control Variables, Fixed Effects, Nonlinearity

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 (April 16, 2019). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3404533

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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