Firm-specific Return Variation Research Articles

A closer look at the relationship between firm-specific return variation and stock returns

PurposePrior studies use two measures of firm-specific return variation (FSRV): idiosyncratic volatility in absolute and relative terms, the latter of which is also termed stock price nonsynchronicity. Whereas most research focuses on investigating the idiosyncratic volatility puzzle, the authors carry out comparison of these two measures and further investigate which of the two constituents of nonsynchronicity explain the association between FSRV and stock returns, emphasising the importance of assessing which component drives stock returns.Design/methodology/approachThe authors use the US individual stock returns from 1925 to 2016 and define the two measures of FRSV based on the Fama and French (1993) model. Specifically, the authors decompose the relative measure into two components: (i) absolute idiosyncratic volatility and (ii) systematic volatility. The authors conduct various tests based on high-minus-low, zero-investment quintile portfolio sorts and perform the Fama–MacBeth analysis by singling out each component.FindingsThe authors find a positive return on the portfolio sorted on relative idiosyncratic volatility or on systematic volatility, but find a negative return sorted on absolute idiosyncratic volatility. The results are robust after controlling for size, BM and other risk characteristics using a double-sorting approach. The Fama–MacBeth regression results show that a positive association between the relative measure and stock returns is driven primarily by the low-systematic-volatility anomaly across firms. The findings are robust to controlling for return residual momentum, skewness, jumps and information discreteness.Originality/valueExtant research posits the idiosyncratic volatility puzzle and the low-volatility anomaly. The authors emphasize the importance of integrating these two streams of research. This study enhances the understanding of the driving force underlying the relationship between FSRV and cross-sectional stock returns.

Do investors listen? Exploring the effect of investor relationship management on firm-specific stock return variation

In this study, we combine the National Investor Relations Institute Index of Marketization of China’s Provinces 2016 report with Nankai University’s investor relationship management index to examine the influence of investor relationship management on firm-specific stock return variation. Our results indicate a significant positive relationship between a firm’s investor relationship management and the magnitude of firm-specific return variation in its stock. Our results further show that the relationship varies across different regions in China due to differences in the institutional environment. Specifically, firms in regions with a high level of marketization, a high degree of rule of law, and a low degree of government intervention exhibit a stronger relationship. These results provide important implications for policy makers and corporate managers and help enhance corporate governance and firm valuation.

Private information in trades, R2, and large stock price movements

We investigate the relations between trading-conveyed private information and stock return distributions. Using high-frequency measures of private information, we find that private information in trades is associated with lower stock return synchronicity. We also find private information in trades is positively associated with stock price crashes and positive stock price jumps. Our results are robust to several specification checks, including the use of alternative private information proxies, various model specifications, and different time periods. Overall, we demonstrate that trading conveyed private information reduces stock return synchronicity and predicts the frequency of crashes and jumps. Our findings can be useful for market makers, regulators, and traders, who are interested in firm-specific return variation and extreme stock price movements at high frequencies.

OPEN MARKET REPURCHASES AND STOCK PRICE INFORMATIVENESS: EVIDENCE FROM MALAYSIA STOCK MARKET

Abstract 
 The aim of research paper is to examine the effect of stock price informativeness, which is conveyed by stock prices, on firm’s open market repurchases (OMRs) activity. The finding of study is to provide evidence of presence of managerial learning whereby managers could use firm-specific stock return variation to buy back their shares via open market. Evidence is found in the subsample analysis where target sample is separated to two subsamples periods and test separately based on stock market performance. The finding of the 1st subsample (Q12008-Q42013) for OMRs activity indicates that variation of stock return and firm size significantly and positively explains OMRs activity. The finding of 1st subsample is robust in terms of random and fixed effect model. The finding implies that managers observed and learned information from firm-specific variation in stock return during financial crisis and recovery periods when performing open market repurchases.
 Keywords: Open market repurchase, managerial learning hypothesis, stock price informativeness, firm-specific return variation, informed trading.

The Relationship between Firm-Specific Return Variation and Price Informativeness: Some Cross-Sectional Evidence

The progressive removal of short-selling constraints in the Chinese stock market provides us with a natural experiment to investigate the relationship between firm-specific return variation (FSRV) and price informativeness. Based on the empirical finding that idiosyncratic volatility is a satisfied proxy for FSRV when the information environment for individual firms improves, we mainly find that the FSRV is negatively related to price informativeness. This negative relationship is robust to alternative model specifications, alternative proxies for price informativeness, and alternative estimation windows. Generally speaking, our results complement the extant literature on the mixed relationships between FSRV and price informativeness by providing cross-sectional evidence.

Idiosyncratic volatility: An indicator of noise trading?

Abstract We investigate the market efficiency implications of firm-specific return variation measured by absolute idiosyncratic volatility. We find that the absolute idiosyncratic volatility (the variance of the residual from an asset-pricing model) displays a positive and robust relationship to mispricing, which reflects an increasing role of noise traders. Previous literature has produced similar – or opposing – results. We deepen our understanding of the previous conflicting results by showing that (1) market volatility by itself is associated with mispricing, (2) absolute idiosyncratic volatility is associated with mispricing even when controlling for market volatility, (3) the strength of the association between absolute idiosyncratic volatility and mispricing depends on the level of market volatility, and (4) absolute and relative measures of idiosyncratic volatility have opposing associations with mispricing. Our findings contribute to the existing literature by reconciling the mixed results for the relationship between idiosyncratic volatility and mispricing displayed in the previous literature.

R2 and idiosyncratic volatility: Which captures the firm-specific return variation?

A growing literature regards R2 and idiosyncratic volatility as interchangeable proxies for firm-specific return variation and examines its relations to information efficiency. However, the question on choosing the appropriate proxy, i.e., R2 or idiosyncratic volatility, is less investigated. This paper provides alternative evidences that R2 and idiosyncratic volatility are not interchangeable with the utilization of a unique short selling mechanism in China. Specifically, we mainly find that 1) R2 is not a satisfied proxy when the information environment for individual firm is improved, while idiosyncratic volatility is a satisfied proxy under the improved information environment; 2) R2 and idiosyncratic volatility are satisfied proxies for firm-specific return variation when the information environment for individual firm is deteriorated. These results also complement the existing literature on figuring out the appropriate proxy for firm-specific return variation under different information environment.

Information Efficiency and Firm-Specific Return Variation

Reasoning that private firm-specific information causes firm-specific return variation that drives down market-model R2s, [Morck et al., 2000, The Information Content of Stock Markets: Why do Emerging Markets have Synchronous Stock Price Movements? Journal of Financial Economics, 58, 215–260] 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.

R2 and Idiosyncratic Risk Are Not Interchangeable

ABSTRACT A growing literature investigates the association between stock return variation and several aspects of information and governance structures, in both a cross-country setting and a cross-firm setting within the U.S. Papers use either idiosyncratic stock return volatility or R2 as interchangeable measures of firm-specific return variation but report inconsistent results. An important reason for the differing interpretations is the assumption about whether lower R2 (or higher ) captures firm-specific news or noise. We document that higher (or equivalently, lower R2) resembles noise. In addition, we show, analytically and empirically, that different results obtain when using R2 or because the systematic risk inherent in the R2 metric is also correlated with the independent variable of interest. Therefore, we recommend that when assessing the association between R2 (or ) and some independent variable, researchers (1) control for elements of systematic risk and (2) triangulate their findings with other measures of information environment. Data Availability: The data in this study are available from commercial providers, e.g., WRDS, Compustat, CRSP, I/B/E/S.

A dynamic intraday measure of the probability of informed trading and firm-specific return variation

Abstract A central question in financial economics is how private information is incorporated into asset prices. A common method of measuring private information is the PIN measure, which uses statistical estimation of a sequential trade model of the trading process to estimate the probability of informed trading. A notable limiting feature of PIN is that one must aggregate very fine intraday data over very long macro horizons in order to estimate it. In this paper, our aim is to develop and implement a dynamic intraday measure of the probability of informed trading that circumvents this aggregation issue and allows for the measurement of information based trading activity at much higher frequencies. We then apply our dynamic intraday measure of the probability of informed trading to examine the relationship between private information and firm-specific return variation.

Does accounting conservatism improve the corporate information environment?

This study investigates whether and how accounting conservatism improves the corporate information environment. We argue that conservatism facilitates the flow of firm-specific information from corporate insiders to outsiders and leads to a high-quality information environment. Using the Basu (1997) model to capture the extent of accounting conservatism and firm-specific return variation to proxy for the quality of information environment, we find that conservatism is positively associated with the improvement of the corporate information environment in our sample of 43 countries. We also find that the information role of conservatism is more pronounced in countries with weaker protection of private property rights, suggesting that conservatism substitutes for legal institutions in ensuring the quality of information environment.

Informed trade and idiosyncratic return variation

This paper explores the role of private information on idiosyncratic return variation. We suggest that there is a significant positive relationship between informed trade and firm-specific return variation. Using the probability of information-based trading (PIN) as a measure of informed trade, we find that the PIN is positively related to idiosyncratic return variation in both the level and the first-difference. The results imply that firm-specific return variation is induced by informed trade through information flow on price formation. Especially, we find a strong interaction effect between informed trade and trading volume. The impact of informed trade on firm-specific return variation is more profound for stocks with a high trading volume than for stocks with a low trading volume. The result suggests that trading activity plays an important role in the information revelation. The results of various robustness checks confirm that informed trade is an important determinant of idiosyncratic return variation.

The Impact of Informed Trade on Firm-Specific Return Variation

Based on the notion that private information necessarily accompanies trade and leads to return variation, this paper explores the positive relationship between informed trade and firm-specific return variation. Using the PIN as a measure of informed trade, we find that the PIN is positively related to firm-specific return variation. We also find a significant interaction effect such that the impact of informed trade on firm-specific return variation is more profound for stocks with a high trading volume than for stocks with a low trading volume. The results of various robustness checks confirm that informed trade is indeed an important determinant of firm-specific return variation.

R2 and Idiosyncratic Risk are not Interchangeable

A growing literature investigates the association between firm-specific stock return variation (the dependent variable) and several aspects of firms’ information and governance structures. However, several papers in this literature use the variance of residual returns from a market model (sigma squared) as the measure of firm-specific return variation whereas others use return synchronicity, or R2. Although, at first blush, these two variables appear equivalent, we show that the specific dependent variable used, sigma squared or R2, can lead to contradictory inferences due to both econometric and economic considerations. Further tests suggest that, contrary to the traditional interpretation in the literature, lower R2 is associated with poorer information environments, measured as higher price delays, higher PIN scores, greater levels of illiquidity, more zero return days and higher bid-ask spreads.

Stock Price Informativeness and Output Growth: Some Evidence from Emerging Economies

This paper extends the output growth model tested by Levine and Zervos (1998) by including a measure for capital allocation efficiency proxied by stock price informativeness. Using a sample of 62 countries, this study finds that stock price informativeness as measured by firm-specific return variation positively contributes to output growth after controlling for variables in the Levine and Zervos (1998) model. This effect is particularly strong for high property rights protection environments and common law countries in emerging economies. We find that stock price informativeness acts as a substitute for stock market liquidity on predicting long-run output growth in emerging economies but not in more developed economies. These results are consistent with the Roll’s (1988) claim: more information-laden stock prices signal efficient stock markets and, therefore, stronger output growth.

Firm fundamentals and stock prices in emerging Asian stock markets: some panel data evidence

The purpose of this paper is to investigate the direct link between firm fundamentals and stock prices in a set of emerging Asian stock markets using firm-level panel data. In doing so, we explore the relationship between firm-specific variations in stock returns and firm fundamentals in the context of a simple present value framework. We find that alternative proxies of variation in firm fundamentals—albeit at differing degrees—explain a significant part of firm-specific return variation in a majority of emerging markets in Asia. Findings are robust to the influence of other factors known to affect stock return volatility (e.g. firm size, stock turnover, and leverage). Overall results suggest that stock prices in a majority of the Asian emerging markets contain a significant amount of firm-specific fundamental information and are, therefore, not as murky as commonly thought.

Stock Price Informativeness, Analyst Coverage and Economic Growth: Evidence from Emerging Markets

This paper extends the output growth model tested by Levine and Zervos (1998) by including a channel for capital allocation efficiency proxied by stock price informativeness. Using a sample of 59 countries, this study finds that stock price informativeness as measured by firm-specific return variation is positively associated with output growth after controlling for variables in the Levine and Zervos’s (1998) model. We find that stock price informativeness acts as a substitute for stock market liquidity in predicting output growth. These results are consistent with the Roll’s (1988) claim: more information-laden stock prices signal efficient stock markets and, therefore, stronger output growth. We also find that firms in emerging economies covered by more analysts incorporate greater (lesser) systematic-wide (firm-specific) information which impede the role of stock price informativeness on facilitating output growth.

Stock Markets, Banks and Economic Growth: Some Evidence on the Role of Stock Price Informativeness

This paper extends the economic growth model tested by Levine and Zervos (1998) by including a measure for capital allocation efficiency proxied by stock price informativeness. Using a sample of 59 countries, this study finds that stock price informativeness as measured by firm-specific return variation is positively associated with economic growth after controlling for variables in the Levine and Zervos’s (1998) model. However, when we split the countries into emerging versus developed countries, we find that stock price informativeness acts as a substitute for banking development and stock market liquidity in predicting economic growth in emerging countries but not in more developed countries. These results are consistent with the Roll’s (1988) claim: more information-laden stock prices signal efficient stock markets and, therefore, stronger economic growth.

Corporate governance and the divergence of learning channels

We study the relation between corporate governance, market liquidity and stock price informativeness. Firms with more informative stock prices are associated with larger transaction volume, larger bid-ask spread and better corporate governance. Thisliquidity-informativeness relation is significant for firms with high antitakeover provision (bad corporate governance). However, bid-ask spread is insignificantly associated withprice informativeness for firms with less antitakeover provision (good corporate governance). This supports that firm-specific return variation better measures stock price informativeness when firm has strong corporate governance framework. Our results suggest that (i) more (less) informed trading activities associated with weak (strong) corporate governance, and (ii) corporate governance explains the cross-sectional variation in information efficiency of stock prices. Our results are consistent with theories in financial market learning that investor learn from informed trading activities associated with weak governance firms and informative disclosure from strong governance firms.

Firm-specific stock return variation and capital structure decisions

We evaluate the association between the pace of the adjustment toward target capital structure and the extent to which equity prices reflect firm-specific information. The evidence indicates that firm-specific stock return variation explains significantly the pace of the adjustment toward target capital structure. We also show that the financing decisions of most Taiwanese firms support trade off theory. Only the samples of high (low) firm-specific stock return variation support pecking order (market timing) theory. Our findings suggest that firm-specific stock return variation provides considerable insight to capital structure decisions. In other words, corporate financing decisions cannot divorce from the efficiency of capital markets.