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

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  • Zhang, Wei
  • Li, Xiao
  • Shen, Dehua
  • Teglio, Andrea

Abstract

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.

Suggested Citation

  • Zhang, Wei & Li, Xiao & Shen, Dehua & Teglio, Andrea, 2016. "R2 and idiosyncratic volatility: Which captures the firm-specific return variation?," Economic Modelling, Elsevier, vol. 55(C), pages 298-304.
    • Handle: RePEc:eee:ecmode:v:55:y:2016:i:c:p:298-304
    DOI: 10.1016/j.econmod.2016.02.025
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    4. Ahmad Fraz & Arshad Hassan, 2017. "Stock Price Synchronicity and Information Environment," Business & Economic Review, Institute of Management Sciences, Peshawar, Pakistan, vol. 9(4), pages 213-232, December.
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    7. Shen, Dehua & Li, Xiao & Xue, Mei & Zhang, Wei, 2017. "Does microblogging convey firm-specific information? Evidence from China," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 482(C), pages 621-626.
    8. Li, Xiao & Xing, Yao, 2023. "When stock return synchronicity meets investor sentiment," Finance Research Letters, Elsevier, vol. 53(C).
    9. Feng, Xunan & Chan, Kam C., 2016. "Information advantage, short sales, and stock returns: Evidence from short selling reform in China," Economic Modelling, Elsevier, vol. 59(C), pages 131-142.
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    15. Chen Chen & M. Mahdi Moeini Gharagozloo & Layla Darougar & Lei Shi, 2022. "The way digitalization is impacting international financial markets: Stock price synchronicity," International Finance, Wiley Blackwell, vol. 25(3), pages 396-415, December.
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    18. Li, Xiao & Shen, Dehua & Zhang, Wei, 2018. "Do Chinese internet stock message boards convey firm-specific information?," Pacific-Basin Finance Journal, Elsevier, vol. 49(C), pages 1-14.
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    21. Shen, Dehua & Tong, Zezheng & Goodell, John W., 2024. "Do online message boards convey cryptocurrency-specific information?," International Review of Financial Analysis, Elsevier, vol. 91(C).

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    More about this item

    Keywords

    R2; Idiosyncratic volatility; Short selling; Firm-specific return variation; Information environment;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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