Information Efficiency and Firm-Specific Return Variation

Forthcoming in the Quarterly Journal of Finance

53 Pages Posted: 23 Mar 2007 Last revised: 29 Sep 2014

Multiple version iconThere are 2 versions of this paper

Date Written: September 29, 2014

Abstract

Reasoning that private firm-specific information causes firm-specific return variation that drives down market-model R2s, Morck, Yeung, and Yu (2000) begin a large body of research which interprets R2 as an inverse measure of price informativeness. Low R2s or “synchronicity,” as it is called in this literature, signal that prices more efficiently incorporate private firm-specific information, and high R2s indicate less. For this to be true, we would expect that low-R2 stocks have characteristics that facilitate private informed trade, i.e. lower information costs and fewer impediments to arbitrage. However, in this paper we document the opposite: Low-R2 stocks are small, young, and followed by few analysts, and have high bid-ask spreads, high price impact, greater short-sale constraints and are infrequently traded. In fact, microstructure measures suggest that private-information events are less likely for low-R2 stocks than high, and that differences in R2 are driven as much by firm-specific volatility on days without private news as by firm-specific volatility on days with private news. These results call into question prior research using R2 to measure the information content of stock prices.

Keywords: Market efficiency, idiosyncratic volatility, information efficiency, Synchronicity

JEL Classification: G12, G14

Suggested Citation

Kelly, Patrick J., Information Efficiency and Firm-Specific Return Variation (September 29, 2014). Forthcoming in the Quarterly Journal of Finance, Available at SSRN: https://ssrn.com/abstract=972775 or http://dx.doi.org/10.2139/ssrn.972775

Patrick J. Kelly (Contact Author)

The University of Melbourne ( email )

The University of Melbourne
Faculty of Business and Economics
Melbourne, Victoria 3010 3010
Australia

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