Faculty Publications

Idiosyncratic Volatility Covariance And Expected Stock Returns

Document Type

Article

Journal/Book/Conference Title

Financial Management

Volume

42

Issue

3

First Page

517

Last Page

536

Abstract

Given that the idiosyncratic volatility (IDVOL) of individual stocks co-varies, we develop a model to determine how aggregate idiosyncratic volatility (AIV) may affect the volatility of a portfolio with a finite number of stocks. In portfolio and cross-sectional tests, we find that stocks whose returns are more correlated with AIV innovations have lower returns than those that are less correlated with AIV innovations. These results are robust to controlling for the stock's own IDVOL and market volatility. We conclude that risk-averse investors pay a premium for stocks that pay well when AIV is high, consistent with our model. © 2013 Financial Management Association International.

Department

Department of Finance

Original Publication Date

9-1-2013

DOI of published version

10.1111/fima.12019

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