Illiquidity and the measurement of stock price synchronicity

Abstract

This paper demonstrates that measures of stock price synchronicity based on market model R2s are predictably biased downwards as a result of stock illiquidity, and that previously?employed remedies to correct market model betas for measurement bias do not fix R2. Using a large international sample of firm?years, we find strong negative and nonlinear relations between illiquidity and R2 across countries, across firms, and over time. Because variables of interest frequently relate to illiquidity as well, we illustrate the consequences of not controlling for illiquidity in synchronicity research. More generally, we demonstrate the importance of using nonlinear control variable methods. Overall, we conclude that the illiquidity?driven measurement bias in R2 provides an explanation for why prior research finds low?R2 firms to have weak information environments, and suggest future research carefully evaluate the sensitivity of its results to nonlinear controls for illiquidity.

Beteiligte Institutionen

Die Hauptstandorte vom TRR 266 sind die Universität Paderborn (Sprecherhochschule), die HU Berlin und die Universität Mannheim. Alle drei Standorte sind seit vielen Jahren Zentren für Rechnungswesen- und Steuerforschung. Hinzu kommen Wissenschaftler der LMU München, der Frankfurt School of Finance and Management, der WHU – Otto Beisheim School of Management, der ESMT Berlin, der Goethe-Universität Frankfurt und der Carl von Ossietzky Universität Oldenburg, die die gleiche Forschungsagenda verfolgen.