Idiosyncratic Volatility Matters for the Cross-Section of Returns— in More Ways Than One!
This article re-examines the relationship between idiosyncratic volatility and the cross-section of stock returns. Previous studies, using total realized returns as proxies for expected returns, have found ambiguous and conflicting relationships between expected idiosyncratic volatility and expected returns. We decompose idiosyncratic volatility into expected and unexpected idiosyncratic volatility, and use unexpected idiosyncratic volatility to control for unexpected returns so that the relationship between expected returns and expected idiosyncratic volatility can be observed with more clarity. We find expected idiosyncratic volatility to be significantly and positively related to expected returns. In addition, we find evidence suggesting that unexpected idiosyncratic volatility is positively related to unexpected returns and that this relationship is consistent with the option effect proposed by Merton (1974).
Finance and Financial Management | Portfolio and Security Analysis
China International Conference in Finance, Xi'an, China, July 2006
City or Country
CHUA, Choong Tze; GOH, Choo Yong, Jeremy; and ZHANG, Zhe (Joe).
Idiosyncratic Volatility Matters for the Cross-Section of Returns— in More Ways Than One!. (2006). China International Conference in Finance, Xi'an, China, July 2006. Research Collection Lee Kong Chian School Of Business.
Available at: http://ink.library.smu.edu.sg/lkcsb_research/1074