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R-Squared Around the World: New Theory and New Tests

  • Li Jin
  • Stewart C. Myers
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    Morck, Yeung and Yu (MYY, 2000) show that R2 and other measures of stock market synchronicity are higher in countries with less developed financial systems and poorer corporate governance. MYY and Campbell, Lettau, Malkiel and Xu (2001) also find a secular decline in R2 in the United States over the last century. We develop a model that explains these results and generates additional testable hypotheses. The model shows how control rights and information affect the division of risk-bearing between inside managers and outside investors. Insiders capture part of the firm's operating cash flows. The limits to capture are based on outside investors' perception of the value of the firm. The firm is not completely transparent, however. Lack of transparency shifts firm-specific risk to insiders and reduces the amount of firm-specific risk absorbed by outside investors. Our model also predicts that opaque' stocks are more likely to crash, that is, to deliver large negative returns. Crashes occur when insiders have to absorb too much firm-specific bad news and decide to give up.' We test these predictions using stock returns from all major stock markets from 1990 to 2001. We find strong positive relationships between R2 and several measures of opaqueness. These measures also explain the frequency of large negative returns.

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    File URL: http://www.nber.org/papers/w10453.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10453.

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    Date of creation: Apr 2004
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    Publication status: published as Jin, Li and Stewart C. Myers. "R2 Around The World: New Theory And New Tests," Journal of Financial Economics, 2006, v79(2,Feb), 257-292.
    Handle: RePEc:nbr:nberwo:10453
    Note: CF
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    1. R. Gaston Gelos & Shang-Jin Wei, 2002. "Transparency and International Investor Behavior," NBER Working Papers 9260, National Bureau of Economic Research, Inc.
    2. Arturo Bris & William N. Goetzmann & Ning Zhu, 2004. "Efficiency and the Bear: Short Sales and Markets around the World," Yale School of Management Working Papers ysm15, Yale School of Management.
    3. Raghuram G. Rajan & Luigi Zingales, 2001. "Financial Systems, Industrial Structure, and Growth," Oxford Review of Economic Policy, Oxford University Press, vol. 17(4), pages 467-482.
    4. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    5. Barry, Christopher B. & Jennings, Robert H., 1992. "Information and Diversity of Analyst Opinion," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(02), pages 169-183, June.
    6. La Porta, Rafael & Lopez-de-Silanes, Florencio & Schleifer, Andrei & Vishny, Robert, 2001. "Investor Protection and Corporate Governance," Working Paper Series rwp01-017, Harvard University, John F. Kennedy School of Government.
    7. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1989. "The Size and Incidence of the Losses from Noise Trading," Journal of Finance, American Finance Association, vol. 44(3), pages 681-696, 07.
    8. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1991. "The Survival of Noise Traders in Financial Markets," Scholarly Articles 3725470, Harvard University Department of Economics.
    9. David Easley & Maureen O'hara, 2004. "Information and the Cost of Capital," Journal of Finance, American Finance Association, vol. 59(4), pages 1553-1583, 08.
    10. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, . "Noise Trader Risk in Financial Markets," J. Bradford De Long's Working Papers _124, University of California at Berkeley, Economics Department.
    11. Joseph Chen & Harrison Hong & Jeremy C. Stein, 2000. "Forecasting Crashes: Trading Volume, Past Returns and Conditional Skewness in Stock Prices," NBER Working Papers 7687, National Bureau of Economic Research, Inc.
    12. Rafael La Porta & Florencio Lopezde-Silanes & Andrei Shleifer, 2000. "Government Ownership of Banks," NBER Working Papers 7620, National Bureau of Economic Research, Inc.
    13. Wurgler, Jeffrey, 2000. "Financial markets and the allocation of capital," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 187-214.
    14. Randall Morck & Bernard Yeung & Wayne Yu, 1999. "The Information Content of Stock Markets: Why Do Emerging Markets Have Synchronous Stock Price Movements?," Harvard Institute of Economic Research Working Papers 1879, Harvard - Institute of Economic Research.
    15. Stewart C. Myers, 2000. "Outside Equity," Journal of Finance, American Finance Association, vol. 55(3), pages 1005-1037, 06.
    16. Randolph B. Cohen & Christopher Polk & Tuomo Vuolteenaho, 2003. "The Value Spread," Journal of Finance, American Finance Association, vol. 58(2), pages 609-642, 04.
    17. Dimson, Elroy, 1979. "Risk measurement when shares are subject to infrequent trading," Journal of Financial Economics, Elsevier, vol. 7(2), pages 197-226, June.
    18. Malkiel, Burton & Campbell, John & Lettau, Martin & Xu, Yexiao, 2001. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," Scholarly Articles 3128707, Harvard University Department of Economics.
    19. repec:rus:hseeco:52003 is not listed on IDEAS
    20. Conrad, Jennifer & Kaul, Gautam, 1988. "Time-Variation in Expected Returns," The Journal of Business, University of Chicago Press, vol. 61(4), pages 409-25, October.
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