Publication Type

Journal Article

Version

Preprint

Publication Date

7-2016

Abstract

We propose a simple methodology to evaluate a large number of potential explanations for the negative relation between idiosyncratic volatility and subsequent stock returns (the idiosyncratic volatility puzzle). We find that surprisingly many existing explanations explain less than 10% of the puzzle. On the other hand, explanations based on investors’ lottery preferences, short-term return reversal, and earnings shocks show greater promise in explaining the puzzle. Together they account for 60-80% of the negative idiosyncratic volatility-return relation. Our methodology can be applied to evaluate competing explanations for a broad range of topics in asset pricing and corporate finance.

Keywords

idiosyncratic volatility, cross-section of stock returns, lottery preferences, market frictions

Discipline

Corporate Finance | Portfolio and Security Analysis

Research Areas

Finance

Publication

Journal of Financial Economics

Volume

121

Issue

1

First Page

167

Last Page

194

ISSN

0304-405X

Identifier

10.1016/j.jfineco.2016.02.013

Publisher

Elsevier

Additional URL

http://dx.doi.org/10.1016/j.jfineco.2016.02.013

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