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R2 and Idiosyncratic Volatility: Which Captures the Firm-specific Return Variation?

Author

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  • Wei Zhang

    (College of Management and Economics, China Center for Social Computing & Analytics, Tianjin University, China)

  • Xiao Li

    (College of Management and Economics, China Center for Social Computing & Analytics, Tianjin University, China)

  • Dehua Shen

    (Department of Economics, Universitat Jaume I, Castellón, Spain)

  • Andrea Teglio

    (Department of Economics, Universitat Jaume I, Castellón, Spain)

Abstract

A growing literature regards R2 and idiosyncratic volatility as the proxies for firm-specific return variation and examines their role in several aspects of firm's information environment. However, the question on choosing the appropriate proxy, i.e., R2 or idiosyncratic volatility, has been completely ignored. In this paper, given the unique short selling mechanism in China, we examine the changes in R2 and idiosyncratic volatility around the demarcation of information environment, respectively. The empirical findings suggest that both R2 and idiosyncratic volatility are satisfying proxies for firm-specific return variation when the information environment for individual firm is deteriorated. The R2 may not be a suitable proxy when the information environment for individual firm is improved. In that sense, we caution scholars to consider the development of capital market and the speed of information diffusion when adopting our results.

Suggested Citation

  • Wei Zhang & Xiao Li & Dehua Shen & Andrea Teglio, 2015. "R2 and Idiosyncratic Volatility: Which Captures the Firm-specific Return Variation?," Working Papers 2015/06, Economics Department, Universitat Jaume I, Castellón (Spain).
    • Handle: RePEc:jau:wpaper:2015/06
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    6. Shen, Dehua & Li, Xiao & Zhang, Wei, 2018. "Baidu news information flow and return volatility: Evidence for the Sequential Information Arrival Hypothesis," Economic Modelling, Elsevier, vol. 69(C), pages 127-133.
    7. Zhang, Yongjie & Song, Weixin & Shen, Dehua & Zhang, Wei, 2016. "Market reaction to internet news: Information diffusion and price pressure," Economic Modelling, Elsevier, vol. 56(C), pages 43-49.
    8. Xiong, Xiong & Meng, Yongqiang & Li, Xiao & Shen, Dehua, 2020. "Can overnight return really serve as a proxy for firm-specific investor sentiment? Cross-country evidence," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 64(C).
    9. Meng, Yongqiang & Shen, Dehua & Xiong, Xiong, 2023. "When stock price crash risk meets fundamentals," Research in International Business and Finance, Elsevier, vol. 65(C).
    10. Peng, Cheng & Zhu, Huiming & Jia, Xianghua & You, Wanhai, 2017. "Stock price synchronicity to oil shocks across quantiles: Evidence from Chinese oil firms," Economic Modelling, Elsevier, vol. 61(C), pages 248-259.
    11. 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.
    12. Chu, Gang & Li, Xiao & Zhang, Yongjie, 2022. "Information demand and net selling around earnings announcement," Research in International Business and Finance, Elsevier, vol. 59(C).
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    14. 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.
    15. Todea, Alexandru & Petrescu, Daiana Florina, 2021. "Is stock price informativeness shaped by our genes?," Economic Modelling, Elsevier, vol. 103(C).
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    More about this item

    Keywords

    R2; Idiosyncratic volatility; Short selling; Firm-specific return variation; Quasi-natural experiment; 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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