Unusual News Events and the Cross-Section of Stock Returns

Abstract:     
We show that stocks that experience a sudden increase in idiosyncratic volatility earn abnormally high contemporaneous returns but significantly underperform otherwise similar stocks in the future. Our findings indicate that volatility jumps can be traced to unusual firm-level news. We conjecture that these unusual news events increase the level of investor disagreement about firms' fundamental values. Because short-selling of highly volatile stocks is costly, prices rise to reflect the more optimistic views but then revert down as investors' opinions start to converge. The observed patterns of trade order imbalances and effective spreads lend support for this hypothesis.

Keywords: unusual news events, volatility shocks, differences of opinion

JEL Classifications: G10, G12, G14

Working Paper Series