Information Efficiency and Firm-Specific Return Variation

Abstract

Reasoning that private firm-specific information causes firm-specific return variation that drives down market-model R 2 s, Morck, Yeung, and Yu (2000) begin a large body of research which interprets R 2 as an inverse measure of price informativeness. Low R 2 s or "synchronicity," as it is called in this literature, signal that prices more efficiently incorporate private firm-specific information, and high R 2 s indicate less. For this to be true, we would expect that low-R 2 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-R 2 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-R 2 stocks than high, and that differences in R 2 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 R 2 to measure the information content of stock prices.

Stock Price Synchronicity and Information Environment

“…Chan and Hameed (2006) assume that SPS is positively related to the extent of analyst coverage, firm size, and trading volume. In subsequent study, these findings are supported by Kelly (2014), who argues that the SPS is inconsistent to firm specific fundamentals.…”

“…Roll (1988) finds the effect of public news on the volatility of returns, but this impact is relatively small. Due to this reason, microstructure variables should be used for information incorporation (Kelly, 2014). In this study, firm specific attributes are used to examine the quality of information for Pakistani equity market.…”

“…These firms also have more diversified operations and have more synchronize trading with market resulting positive association between size and SPS (Piotroski & Roulston, 2004;Hameed, 2006 andAshbaugh-Skaife et al, 2006). Kelly (2014) argues that analysts prepare their reports in light of maximum information available to them. This detailed analysis helps investor to get the information and lower the cost of accessibility.…”

“…In contrast, several studies have found inconsistent relationship between R-squared and information incorporation (Chan & Hameed, 2006;Ashbaugh, Gassen & LaFond, 2006;Griffin, Kelly, & Nadari, 2006;Kelly, 2014). Theoretically, several researchers argue that interpretation of information efficiency by R-squared is difficult to measure with standard models (West 1988;Campbell, et al, 2001;Peng & Xiong, 2006).…”

“…That low average R-squared shows market model's predictability power is low and it is a possibility that firm specific variables may contribute more or increase in idiosyncratic volatility (Campbell et al, 2001;Kelly, 2014).…”