Faculty Publications

The Return Impact Of Realized And Expected Idiosyncratic Volatility

Document Type

Article

Keywords

Asset pricing, Idiosyncratic volatility, Limits to arbitrage, Seasonality, Sentiment

Journal/Book/Conference Title

Journal of Banking and Finance

Volume

35

Issue

10

First Page

2547

Last Page

2558

Abstract

We show that the negative relation between realized idiosyncratic volatility, measured over the prior month, and returns is robust in non-January months. Controlling for realized idiosyncratic volatility, we show that the relation between returns and expected idiosyncratic volatility is positive and robust. Realized and expected idiosyncratic volatility are separate and important effects describing the cross-section of returns. We find the negative return on a zero-investment portfolio that is long high realized idiosyncratic volatility stocks and short low realized idiosyncratic volatility stocks is dependent on aggregate investor sentiment. In cross-sectional tests, we find the negative relation is weaker for stocks with a large analyst following and stronger for stocks with high dispersion of analyst forecasts. The positive relation between expected idiosyncratic volatility and returns is not due to mispricing. © 2011 Elsevier B.V.

Department

Department of Finance

Original Publication Date

10-1-2011

DOI of published version

10.1016/j.jbankfin.2011.02.015

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