Firm-specific Return Volatility Research Articles

News and Idiosyncratic Volatility: The Public Information Processing Hypothesis*

Abstract Motivated by the recent availability of extensive electronic news databases and advent of new empirical methods, there has been renewed interest in investigating the impact of financial news on market outcomes for individual stocks. We develop the information processing hypothesis of return volatility to investigate the relation between firm-specific news and volatility. We propose a novel dynamic econometric specification and test it using time series regressions employing a machine learning model selection procedure. Our empirical results are based on a comprehensive dataset comprised of more than 3 million news items for a sample of 28 large U.S. companies. Our proposed econometric specification for firm-specific return volatility is a simple mixture model with two components: public information and private processing of public information. The public information processing component is defined by the contemporaneous relation with public information and volatility, while the private processing of public information component is specified as a general autoregressive process corresponding to the sequential price discovery mechanism of investors as additional information, previously not publicly available, is generated and incorporated into prices. Our results show that changes in return volatility are related to public information arrival and that including indicators of public information arrival explains on average 26% (9–65%) of changes in firm-specific return volatility.

The impact of Earnings Quality on the stock performance in the stock exchange market: Evidence from Egypt

The purpose of the paper is to measure impact of three determinants on the firm performance using the earnings quality as an intermediary variable. The three determinants measured in this research are firm specific return volatility, earnings management, and the corporate governance. The research is applied in the Egyptian stock exchange market, using the constituents of its most active index that is the EGX30 during the time frame 2010-2017. The data have been analyzed by using statistical techniques, like the Jarque-Bera Test, Pearson correlation, and structure equation modeling. The results of the statistical analysis approved the research hypotheses by proving the association among firms’ specific return volatility, earnings management, corporate governance, on firms’ stock performance in the Egyptian stock exchange market, using the earning quality as an intermediary variable.

Does Idiosyncratic Return Volatility Capture Information or Noise?

This paper examines the cross-sectional association between earnings quality and firm-specific return volatility for a sample of UK firms listed in the London Stock Exchange. Identifying the determinants of idiosyncratic volatility has been a topical issue since the Campbell et al. (2001) study which documents a noticeable increase in average firm-level volatility across time. Using panel data, we find that poor information environments resulting from poor earnings quality are associated with higher firm-specific return volatility. This finding is consistent with the noise-based approach of firm-specific return volatility. In addition, we provide empirical evidence that such association becomes stronger after combining accruals quality and the dispersion in analysts' forecasts to describe a poor information environment. These findings are likely to contribute to the debate on whether firm-specific return volatility captures more firm-specific information being impounded in stock prices or essentially reflects noise.

Does idiosyncratic return volatility capture information or noise

This paper examines the cross-sectional association between earnings quality and firm-specific return volatility for a sample of UK firms listed in the London Stock Exchange. Identifying the determinants of idiosyncratic volatility has been a topical issue since the Campbell et al. (2001) study which documents a noticeable increase in average firm-level volatility across time. Using panel data, we find that poor information environments resulting from poor earnings quality are associated with higher firm-specific return volatility. This finding is consistent with the noise-based approach of firm-specific return volatility. In addition, we provide empirical evidence that such association becomes stronger after combining accruals quality and the dispersion in analysts' forecasts to describe a poor information environment. These findings are likely to contribute to the debate on whether firm-specific return volatility captures more firm-specific information being impounded in stock prices or essentially reflects noise.

The association between earnings quality and firm-specific return volatility

Purpose This paper aims to examine the association between earnings quality and firm-specific return volatility for a large sample of Japanese manufacturing firms. Design/methodology/approach This archival research uses idiosyncratic volatility and asynchronicity as two analogous proxies for firm-specific return volatility to investigate its association with earnings quality. Findings Using idiosyncratic volatility and asynchronicity as two comparable proxies for firm-specific return volatility, the author finds contradictory results. The author relates this contradiction to another debate in accounting and finance literature about whether firm-specific return volatility captures firm-specific information or noise. Initially, the author obtains conflicting results because the systematic risk, one of the components of asynchronicity, is highly correlated with earnings quality. After controlling for the systematic risk, the author finds that higher earnings quality is associated with lower firm-specific return volatility. This finding is consistent with the noise-based explanation of firm-specific return volatility. The author also separates earnings quality into an innate component driven by economic fundamentals and a discretionary component driven by managerial discretionary behavior and finds that both components have significant impact on firm-specific return volatility but the innate component has significantly stronger effect than the discretionary component. Originality/value This is the first research study presenting evidence on the association between earnings quality and firm-specific return volatility in the Japanese setting. The findings of this paper are likely to contribute to the resolution of a well-known debate on whether firm-specific return volatility captures more firm-specific information being impounded in stock prices or noise in stock prices.

R 2 and the Economy

The characterization of firm-specific return volatility as the intensity with which firm-specific events occur reconciles many seemingly discordant results. A functionally efficient stock market allocates capital to its highest value uses, which often amounts to financing Schumpeterian creative destruction, wherein creative winner firms outpace destroyed losers, who could be the previous year’s winners. This rise in firm-specific fundamentals volatility elevates firm-specific return volatility in a sufficiently informationally efficient stock market. These linkages are interconnected feedback loops rather than unidirectional chains of causality.

R-Squared and the Economy

Many seemingly discordant results are reconciled if firm-specific return volatility is characterized as the intensity with which firm-specific events occur. A functionally efficient stock market allocates capital to its highest value uses, which often amounts to financing Schumpeterian creative destruction, wherein creative winner firms outpace destroyed losers, who can be last year’s winners. This elevation in firm-specific fundamentals volatility elevates firm-specific return volatility in a sufficiently informationally efficient stock market. These linkages are interconnected feedback loops, rather than unidirectional chains of causality.

Insider trading and firm-specific return volatility

Roll (J Financ 43:541–566, 1988) argues that firm-specific stock return volatility may result either from informed trading or from noise trading that is unrelated to information. In this paper we provide evidence that insider purchases are inversely related to the idiosyncratic volatility of stocks. We also find that stock idiosyncratic volatilities are generally inversely related to future 6- and 12-month returns. Our results are primarily driven by the timing of insider sales rather than insider purchases. The results are consistent with an information-based explanation of firm-specific return volatility.

Capital allocation, stock return volatility and productivity growth in US industries

Using firm-level Compustat data from 1971 to 2000, we report a substantial cross-industry variation of allocative efficiency in capital expenditure in the US economy. Industries with higher allocative efficiency are the ones with higher firm-level value-added growth heterogeneity, higher information transparency captured by firm-specific stock return volatility and faster long-run productivity growth. This finding is consistent with the idea of creative destruction, where a well-functioning market mechanism sharply distinguishes winners from losers and thus enhances economic growth in the long run. Allocative efficiency has a substantial economic significance and explains as much as 24.5% of the difference in long-run industry productivity growth.