Is R-Squared a Measure of Market Inefficiency?

Kewei Hou, Lin Peng and Wei Xiong
Additional contact information
Kewei Hou: Ohio State University
Lin Peng: City University of New York
Wei Xiong: Princeton University

Working Papers from Princeton University. Economics Department.

Abstract: This paper provides a critical evaluation of a widely made argument that stock prices in markets with lower return R2 are more efficient. We show that in a standard rational expectations model, return R2 is independent of the amount of information incorporated into stock prices. Furthermore, an alternative model in which stock price fluctuations are driven by investor sentiment leads to an opposite prediction that lower return R2 is associated with stronger medium-term price momentum and long-term price reversal, two commonly believed signs of market inefficiency. By examining stock returns both in the U.S. and internationally, we found empirical evidence consistent with this contrasting prediction. Overall, our analysis casts doubt on the argument that low return R2 is a measure of market efficiency.

Keywords: Stocks; R2; Stock Prices; Market Efficiency (search for similar items in EconPapers)
JEL-codes: G14 (search for similar items in EconPapers)
Date: 2013-04
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://wxiong.mycpanel.princeton.edu/papers/R2.pdf

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pri:econom:2013-8

Access Statistics for this paper

More papers in Working Papers from Princeton University. Economics Department. Contact information at EDIRC.
Bibliographic data for series maintained by Bobray Bordelon ().