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4th Annual Conference on
Emerging Markets Finance
March 9-11, 2005
University of Virginia
Stock Price Synchronicity and Analyst
Coverage in Emerging Markets
and
R2 Around the World: New Theory
and Tests
Discussion by Campbell R. Harvey
Duke University and NBER
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4th Annual Conference on
Emerging Markets Finance
The Common Theme


Both papers study how stocks in
international markets move together
(synchronicity)
Both use R2 (stock return regressed on
market return) as measure of synchronicity
R2
~
(market-wide info)
------------------------------------------------(market-wide info + firm-specific info)
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4th Annual Conference on
Emerging Markets Finance
The Research Setting

Roll (1988)
– U.S. stocks have low R2

Campbell, Lettau, Malkiel, Xu (2001)
– R2 decreasing over time for U.S. stocks

Morck, Yeung, Yu (2000)
– Higher R2 in emerging markets than developed markets

Piotroski, Roulstone (2004)
– Different market participants’ info generating activities
and their effect on R2. Security analysts do not have an
advantage over insiders or institutional investors
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4th Annual Conference on
Emerging Markets Finance
The Differences

Jin, Myers (JM)
– Explain differences in R2 across countries

Chan, Hameed (CH)
– Explain differences in R2 across firms
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4th Annual Conference on
Emerging Markets Finance
The Differences

Both study role of information in
explaining differences in R2

JM: link R2 with opaqueness

CH: link R2 with analyst activity
* * *
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4th Annual Conference on
Emerging Markets Finance
Jin-Myers Model


Model first predicts R2 increases with
opaqueness
Why?
– Insiders know more firm-specific info than
outsiders (info asymmetry)
– Insiders bear part of firm-specific risk on
behalf of outsiders
– Outsiders face relatively more market-wide
risk
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4th Annual Conference on
Emerging Markets Finance
Jin-Myers Model


Model second predicts that crash
frequency increases with opaqueness
Why?
– Insiders can only absorb so much firmspecific bad news
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4th Annual Conference on
Emerging Markets Finance
Opaqueness

JM proxy opaqueness by
– Disclosure (Transparency International)
– Number of auditors per 100,000
– Diversity (dispersion of analysts forecasts)

In emerging markets, driven by
–
–
–
–
Weak disclosure regulation
Little voluntary disclosure
Financial development
Interconnecting companies
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4th Annual Conference on
Emerging Markets Finance
Chan-Hameed Model

CH asks:
– Do analysts generate market-wide info or
firm-specific info?

Prediction for R2:
– If analysts generate relatively more marketwide info => R2 increases with analyst
coverage
– If analysts generate relatively more firmspecific info => R2 decreases with analyst
coverage
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4th Annual Conference on
Emerging Markets Finance
Jin-Myers Results

Findings support predictions:
– R2 increases with opaqueness
– Crash frequency increases with opaqueness
(insiders exercise abandonment option if
conditions get really bad)
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4th Annual Conference on
Emerging Markets Finance
Jin-Myers Contribution

Provides alternative interpretation to Morck,
Yeung, Yu (2000)
– MMY argue property rights protection explains
differences in R2 across countries (weak property rights
discourage informed trading and therefore prevent firmspecific information from getting into prices)



JM: Opaqueness measures has more explanatory
power than property rights measures
JM study effect of opaqueness on higher moments
of stock markets
Find positive effect of kurtosis on R2 – invite
explanations
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4th Annual Conference on
Emerging Markets Finance
Chan-Hameed Results

Findings:
– More analyst coverage increases R2
– Supports hypothesis that analysts generate
relatively more market-wide info
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4th Annual Conference on
Emerging Markets Finance
Chan-Hameed Contribution



Study interaction between analyst
coverage and R2 in emerging markets
Shows that Piostroski, Roulstone (2004)
results for U.S. hold in emerging markets
Tests show that analysts generate marketwide info in emerging markets
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4th Annual Conference on
Emerging Markets Finance
Chan-Hameed Thoughts

Does more analyst coverage lead to more
informative firm-specific news or reduce firmspecific noise?
– Link firm-specific info with future fundamental news
e.g. accounting variables (Durnev, Morck, Yeung,
Zarowin (2001))
– Are market model residuals correlated with future
accounting variables? If higher correlation with high
analysts stocks, then more firm-specific information
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4th Annual Conference on
Emerging Markets Finance
Chan-Hameed Thoughts

Study interaction between opaqueness and
analyst activity
– Do analysts generate relatively more market-wide
info for more opaque firms?
– Regress R2 on both opaqueness measure, analyst
coverage and interaction term between opaqueness
and analyst coverage
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4th Annual Conference on
Emerging Markets Finance
Reconciling the Research

How to reconcile JM and CH findings?
– JM: higher earnings dispersion => increased
opaqueness => increased R2
– CH: higher earnings dispersion => more
disagreement on market-wide news => reduce
positive impact of analyst coverage on R2 =>
decreased R2
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4th Annual Conference on
Emerging Markets Finance
Reconciling the Research




JM measure is country-level
CH measure is firm-level
Forecast dispersion depends on both
opaqueness and disagreement
Possible explanation:
– At country-level, opaqueness component
dominates => R2 increases
– At firm-level, disagreement component
dominates => R2 decreases
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4th Annual Conference on
Emerging Markets Finance
Alternative Opaqueness

Accounting measures
– Earnings aggressiveness, earnings smoothing, loss
avoidance (Bhattacharya, Daouk, Welker (2002))

Corporate governance measures
– Business group membership (Bae, Bailey, Mao
(2005))
– ICRG subcomponents
?
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4th Annual Conference on
Emerging Markets Finance
Alternative Opaqueness

Analyst activity
– Average number of analysts in market
– Analysts’ advantage= average error from naïve
earnings prediction model - average analysts forecast
error.
– Are country-level results be consistent with firmlevel?
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4th Annual Conference on
Emerging Markets Finance
Financial Liberalization


What is the effect of liberalization on the
interaction among R2, opaqueness and analyst
activity?
Bae, Bailey, Mao (2005)
– Study effect of liberalization on info environment

Interesting questions:
– Does liberalization affect R2 through decreased
opaqueness or increased analyst coverage?
– Would increased foreign investor participation
through liberalization increase R2 because foreign
investors rely more on market-wide info?
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4th Annual Conference on
Emerging Markets Finance
Financial Liberalization

Possible measures of liberalization:
– Investibility at country-level (Bekaert,1995)
[country effects will not pick this up because
it changes through time]
– Investibility at firm-level (Bae, Chan, Ng
(2003)) used in CH not JM
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4th Annual Conference on
Emerging Markets Finance
Synchronicity

Cross-sectional volatility (Bekaert, Harvey
(1997))
– Higher cross-section volatility => less market-wide
info
– Advantage: measure is available at higher frequency
than R2

Stock return dispersion
– (Solnik, Roulet (2000), De Silva, Sapra, Thorley
(2001), Statman, Scheid (2004))
– Difference between average individual stock volatility
and volatility of market portfolio
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4th Annual Conference on
Emerging Markets Finance
Other Issues





Results sensitive to sample (old version of paper
used data back to 1989)
Critically important to use Scholes-Williams
market model estimation in emerging market
weekly data – also world factor is omitted in CH
Suspicious of regressions with standardized
variables on LHS and level variables on RHS
Not convinced of the correction for endogeneity
problem
Volume is the noisiest measure in EMDB and is
not a good measure of liquidity
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4th Annual Conference on
Emerging Markets Finance
Liquidity



Considerable evidence that liquidity is a priced
factor
Evidence in emerging markets that local liquidity
is important
Stocks with high analysts following are likely
more liquid. This explains why the high analysts
sort leads the low analysts sort.
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4th Annual Conference on
Emerging Markets Finance
Liquidity

Interesting exercise
– Let the BHL liquidity measures compete with
opaqueness and property rights in the JM
cross-country regression
– Let the BHL liquidity measures compete with
the analysts measures in the firm level
regression in CH
25
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