Evidence on the Presence and Causes of Serial Correlation in Market Model Residuals

Abstract

Studies of returns on common stocks have observed positive market index autocorrelation (see Fisher [10] and Dimson [6]), negative autocorrelation of market model residuals (see Fisher [10] and Fama, Fisher, Jensen, and Roll [9]), and a deterioration in the market model R2 as the returns measurement period is shortened (see Pogue and Solnik [17], Altman, Jacquillat, and Levasseur [1], and Schwartz and Whitcomb [19]). We present further evidence on the strength of these findings and show that they are concurrent events. That is, common factors can explain both positive index and negative residual autocorrelation, and these correlation patterns in turn cause R2 to fall as the differencing interval is shortened.