AND PAUL ZAROWIN‡

grateful for the very helpful comments from the editor, Abbie Smith, and the referee. Roll [1988] observes low R2 statistics for common asset pricing models due to vigorous firms-specific return variation not associated with public information. He concludes (p. 56) that this implies “either private information or else occasional frenzy unrelated to concrete information. ” We show that firms and industries with lower market model R2 statistics exhibit higher association between current returns and future earnings, indicating more information about future earnings in current stock returns. This supports Roll’s first interpretation – higher firms-specific return variation as a fraction of total variation signals more information-laden stock prices and, therefore, more efficient stock markets. Stock markets perform a vital economic role by generating prices that serve as signals for resource allocation and investment decisions. This role has two parts: if stock prices are near their fundamental (full information) values, first, capital is priced correctly in its different uses and, second, this information provides corporate managers with meaningful feedback as stock price