Does Greater Firm-specific Return Variation Mean More or Less Informed Stock Pricing?
University of Iowa - Henry B. Tippie College of Business
National Bureau of Economic Research (NBER); University of Alberta - Department of Finance and Statistical Analysis
Bernard Yin Yeung
National University of Singapore - Business School
New York University (NYU) - Department of Accounting
Journal of Accounting Research, Forthcoming
Roll  observes low R2 statistics for common asset pricing models due to vigorous firms-specific return variation not associated with public information. He concludes (p. 56) that this implies "either private information or else occasional frenzy unrelated to concrete information." We show that firms and industries with lower market model R2 statistics exhibit higher association between current returns and future earnings, indicating more information about future earnings in current stock returns. This supports Roll's first interpretation - higher firms-specific return variation as a fraction of total variation signals more information-laden stock prices and, therefore, more efficient stock markets.
JEL Classification: G12, G14, M41
Date posted: October 17, 2003