Idiosyncratic Volatility and Retail Investor Preferences in the Australian Market

Abstract:     
We explore the negative relation between idiosyncratic volatility and future stock returns observed by previous researchers. We argue that, based on the observation described in prospect theory, retail investors prefer stocks with a high level of idiosyncratic volatility and are subsequently willing to overpay for those stocks. In support of our argument, we find that the negative idiosyncratic-volatility return relation is present in the Australian market, and that this relation is affected by the magnitude of retail trading. The relation is particularly strong when returns and realized volatility are measured at a daily frequency.

Number of Pages in PDF File: 52

Keywords: retail investors, behavioral finance, realized volatility

JEL Classification: G14, G12

working papers series