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

Wei Zhang (), Xiao Li (), Dehua Shen and Andrea Teglio
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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

No 2015/06, Working Papers from Economics Department, 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.

Keywords: R2; Idiosyncratic volatility; Short selling; Firm-specific return variation; Quasi-natural experiment; Information environment (search for similar items in EconPapers)
JEL-codes: G14 G15 (search for similar items in EconPapers)
Pages: 11 pages
Date: 2015
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Journal Article: R2 and idiosyncratic volatility: Which captures the firm-specific return variation? (2016)
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