Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle
Robert F. Stambaugh
University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)
University of Minnesota
Shanghai Advanced Institute of Finance; University of Pennsylvania - Wharton Financial Institutions Center
July 16, 2014
Many investors purchase stock but are reluctant or unable to sell short. Combining this arbitrage asymmetry with the arbitrage risk represented by idiosyncratic volatility (IVOL) explains the negative relation between IVOL and average return. The effect of IVOL on return is negative among overpriced stocks but positive among underpriced stocks, with mispricing determined by combining 11 return anomalies. The negative effect is stronger, consistent with arbitrage asymmetry, and therefore aggregating across all stocks yields a negative relation. Further supporting our explanation is a negative relation over time between the IVOL effect and investor sentiment, especially among overpriced stocks.
Number of Pages in PDF File: 67
Keywords: arbitrage risk, idiosyncratic volatility puzzle, short-sale constraints, investor sentimentworking papers series
Date posted: October 2, 2012 ; Last revised: July 18, 2014
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