Publication Type
Journal Article
Version
acceptedVersion
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
Citation
HOU, Kewei and LOH, Roger.
Have we Solved the Idiosyncratic Volatility Puzzle?. (2016). Journal of Financial Economics. 121, (1), 167-194.
Available at: https://ink.library.smu.edu.sg/lkcsb_research/3503
Copyright Owner and License
Authors
Creative Commons License
This work is licensed under a Creative Commons Attribution-NonCommercial-No Derivative Works 4.0 International License.
Additional URL
https://doi.org/10.1016/j.jfineco.2016.02.013