IDEAS home Printed from
MyIDEAS: Login to save this paper or follow this series

R2 and Price Inefficiency

  • Hou, Kewei

    (Ohio State U)

  • Peng, Lin

    (Baruch College, City U of New York)

  • Xiong, Wei

    (Princeton U)

Motivated by the recent debate on return R2 as an information-efficiency measure, this paper proposes and examines a new hypothesis that R2 is related to investors’ biases in processing information. We provide a model to show that R2 decreases with the degree of the marginal investor’s overreaction to firm-specific information. This theoretical result motivates an empirical hypothesis that stocks with lower R2 should exhibit more pronounced overreaction-driven price momentum. Empirically, we confirm that such a negative relationship between R2 and price momentum exists, and find this relationship robust to controls for risk as well as several alternative mechanisms, such as slow information diffusion, information uncertainty, fundamental R2 and illiquidity. Furthermore, we also document stronger long-run price reversals for stocks with lower R2. Taken together, our results suggest that return R2 could be related to price inefficiency.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: no

Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2006-23.

in new window

Date of creation: Nov 2006
Date of revision:
Handle: RePEc:ecl:ohidic:2006-23
Contact details of provider: Phone: (614) 292-8449
Web page:

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Harrison Hong & Terence Lim & Jeremy C. Stein, 2000. "Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies," Journal of Finance, American Finance Association, vol. 55(1), pages 265-295, 02.
  2. Randall Morck & Bernard Yeung & Wayne Wu, 1999. "The Information Content of Stock Markets: Why do Emerging Markets have Synchronous Stock Price Movements?," William Davidson Institute Working Papers Series 44, William Davidson Institute at the University of Michigan.
  3. Charles M.C. Lee & Bhaskaran Swaminathan, 2000. "Price Momentum and Trading Volume," Journal of Finance, American Finance Association, vol. 55(5), pages 2017-2069, October.
  4. Lin Peng & Wei Xiong, 2005. "Investor Attention: Overconfidence and Category Learning," NBER Working Papers 11400, National Bureau of Economic Research, Inc.
  5. Artyom Durnev & Randall Morck & Bernard Yeung & Paul Zarowin, 2003. "Does Greater Firm-Specific Return Variation Mean More or Less Informed Stock Pricing?," Journal of Accounting Research, Wiley Blackwell, vol. 41(5), pages 797-836, December.
  6. Paul A. Gompers & Andrew Metrick, 1998. "Institutional Investors and Equity Prices," NBER Working Papers 6723, National Bureau of Economic Research, Inc.
  7. Harrison Hong & Jeremy C. Stein, 1997. "A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets," NBER Working Papers 6324, National Bureau of Economic Research, Inc.
  8. Karl B. Diether & Christopher J. Malloy & Anna Scherbina, 2002. "Differences of Opinion and the Cross Section of Stock Returns," Journal of Finance, American Finance Association, vol. 57(5), pages 2113-2141, October.
  9. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
  10. Artyom Durnev & Randall Morck & Bernard Yeung, 2001. "Does Firm-specific Information in Stock Prices Guide Capital Allocation?," NBER Working Papers 8093, National Bureau of Economic Research, Inc.
  11. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1989. "Positive Feedback Investment Strategies and Destabilizing Rational Speculation," NBER Working Papers 2880, National Bureau of Economic Research, Inc.
  12. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  13. John Y. Campbell, 2001. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," Journal of Finance, American Finance Association, vol. 56(1), pages 1-43, 02.
  14. Badrinath, S G & Kale, Jayant R & Noe, Thomas H, 1995. "Of Shepherds, Sheep, and the Cross-autocorrelations in Equity Returns," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 401-30.
  15. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  16. John M. Griffin & Xiuqing Ji & J. Spencer Martin, 2003. "Momentum Investing and Business Cycle Risk: Evidence from Pole to Pole," Journal of Finance, American Finance Association, vol. 58(6), pages 2515-2547, December.
  17. Falkenstein, Eric G, 1996. " Preferences for Stock Characteristics as Revealed by Mutual Fund Portfolio Holdings," Journal of Finance, American Finance Association, vol. 51(1), pages 111-35, March.
  18. Chan, Kalok & Hameed, Allaudeen, 2006. "Stock price synchronicity and analyst coverage in emerging markets," Journal of Financial Economics, Elsevier, vol. 80(1), pages 115-147, April.
  19. Andrei Shleifer & Robert W. Vishny, 1995. "The Limits of Arbitrage," NBER Working Papers 5167, National Bureau of Economic Research, Inc.
  20. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
  21. Patrick J. Kelly, 2014. "Information Efficiency and Firm-Specific Return Variation," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 4(04), pages 1450018-1-1.
  22. Paul J. Irvine & Jeffrey Pontiff, 2009. "Idiosyncratic Return Volatility, Cash Flows, and Product Market Competition," Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1149-1177, March.
  23. Jegadeesh, Narasimhan, 1990. " Evidence of Predictable Behavior of Security Returns," Journal of Finance, American Finance Association, vol. 45(3), pages 881-98, July.
  24. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
  25. West, Kenneth D, 1988. "Dividend Innovations and Stock Price Volatility," Econometrica, Econometric Society, vol. 56(1), pages 37-61, January.
  26. Collins, Daniel W. & Kothari, S. P. & Rayburn, Judy Dawson, 1987. "Firm size and the information content of prices with respect to earnings," Journal of Accounting and Economics, Elsevier, vol. 9(2), pages 111-138, July.
  27. Jeffrey Wurgler, 1999. "Financial Markets And The Allocation Of Capital," Yale School of Management Working Papers ysm123, Yale School of Management, revised 01 Mar 2001.
  28. Brad M. Barber & Terrance Odean, 2000. "Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors," Journal of Finance, American Finance Association, vol. 55(2), pages 773-806, 04.
  29. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
  30. Jin, Li & Myers, Stewart C., 2006. "R2 around the world: New theory and new tests," Journal of Financial Economics, Elsevier, vol. 79(2), pages 257-292, February.
  31. Kent Daniel & David Hirshleifer & Avanidhar Subrahmanyam, 1998. "Investor Psychology and Security Market Under- and Overreactions," Journal of Finance, American Finance Association, vol. 53(6), pages 1839-1885, December.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:ecl:ohidic:2006-23. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.