Idiosyncratic risk and the cross-section of expected stock returns

Have We Solved the Idiosyncratic Volatility Puzzle?

“…On the other hand, maximum daily return (Bali et al (2011)), expected idiosyncratic skewness (Boyer et al (2010)), one-month return reversal (Fu (2009) and Huang et al (2009)), and pre-and post-formation earnings surprises (Wong (2011) and Jiang et al (2009)) show much greater success in explaining the puzzle, although together they still leave 15-40% of the puzzle unexplained. Our decomposition methodology is robust to subsample analysis, using portfolios instead of individual stocks, and potential non-linearity in the idiosyncratic volatility-return relation, and can be easily adapted to evaluate competing explanations for a broad range of topics in empirical asset pricing and corporate finance.…”

“…Fu (2009) and Huang et al (2009) argue that once we control for the one-month return reversal effect, which is likely driven by the bid-ask bounce and other microstructure biases, the negative idiosyncratic volatility-return relation is no longer significant. 8 We measure the onemonth reversal effect using the month t-1 return (Lagret).…”

“…We first consider the one-month return reversal effect (Fu (2009) The results show that neither of them can explain a significant fraction of the puzzle. In fact, the fractions explained are both negative at -8.1% (t=−1.07) and -0.9% (t=−0.42) for Amihud and Zeroret, respectively.…”

“…Most studies in this literature typically 1 Ang, Hodrick, Xing, and Zhang (2009) show that the relation also exists in international markets. 2 The long list of candidate explanations includes those based on expected idiosyncratic skewness (Boyer, Mitton, and Vorkink (2010)), coskewness (Chabi-Yo and Yang (2009)), maximum daily return (Bali, Cakici, and Whitelaw (2011)), retail trading proportion (Han and Kumar (2013)), one-month return reversal (Fu (2009) and Huang, Liu, Rhee, and Zhang (2009)), illiquidity (Bali and Cakici (2008) and Han and Lesmond (2011)), uncertainty (Johnson (2004)), average variance beta (Chen and Petkova (2012)), and earnings surprises (Jiang, Xu, and Yao (2009) and Wong (2011)). In addition, several papers show that the idiosyncratic volatility puzzle is stronger among stocks that are short-constrained (Boehme, Danielsen, Kumar, and Sorescu (2009) and George and Hwang (2011)), in financial distress (Avramov, Chordia, Jostova, and Philipov (2013)), have low investor attention (George and Hwang (2011)), have prices greater than five dollars (George and Hwang (2011)), and in non-January months (George and Hwang (2011) and Doran, Jiang, and Peterson (2012)).…”

Corporate bond prices and idiosyncratic risk: Evidence from Australia

“…Bali, Cakici, Zhe and Yan (2005), however, argue that the results of Goyal et al are driven by small stocks and are period specific. Fu (2009) and Spiegel and Wang (2005) find a significantly positive relation between idiosyncratic volatility and In essence, idiosyncratic volatility measures the magnitude of the firm-specific unexpected return. This is because idiosyncratic volatility, i.e., the square root of idiosyncratic variance, shows the degree of variation in stock returns not captured by common risk factors.…”