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
January 9, 2013
Short selling, as compared to purchasing, faces greater risks and other potential impediments. This arbitrage asymmetry explains the negative relation between idiosyncratic volatility (IVOL) and average return. The IVOL effect 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 asymmetry in risks and other impediments inhibiting arbitrageurs in exploiting overpricing. Aggregating across all stocks therefore yields a negative relation, explaining the IVOL puzzle. 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: 39
Keywords: arbitrage risk, idiosyncratic volatility puzzle, short-sale constraints, investor sentimentworking papers series
Date posted: October 2, 2012 ; Last revised: January 14, 2013
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