The Implications of Low R2: Evidence from China

Motivated by the recent debate on the implications of low R-2 in the U.S. market, we conjecture that lower R-2 is more likely to be associated with noise and low pricing efficiency because stock price tracks its fundamentals more loosely in a less efficient stock market such as China. We conclude that, first, there is no significant difference in information content among stocks with high and low R-2. Second, both accruals anomaly and price momentum are much stronger among firms with lower R-2. Moreover, the price momentum effect is much stronger among stocks with higher DIS, a new proxy constructed to provide a direct description of noise in stock price.