Abstract

http://ssrn.com/abstract=2174541
 
 

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The Common Factor in Idiosyncratic Volatility: Quantitative Asset Pricing Implications


Bernard Herskovic


New York University (NYU)

Bryan T. Kelly


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Hanno N. Lustig


UCLA - Anderson School of Management; National Bureau of Economic Research (NBER)

Stijn Van Nieuwerburgh


New York University Stern School of Business, Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

April 18, 2014

Fama-Miller Working Paper
Chicago Booth Research Paper No. 12-54

Abstract:     
We show that firms' idiosyncratic volatility obeys a strong factor structure and that shocks to the common factor in idiosyncratic volatility (CIV) are priced. Stocks in the lowest CIV-beta quintile earn average returns 6.4% per year higher than those in the highest quintile. We provide evidence that the CIV factor is correlated with income risk faced by households. These three facts are consistent with a canonical incomplete markets heterogeneous-agent model. In the model, CIV is a priced state variable because an increase in idiosyncratic firm volatility raises the typical investor's marginal utility when markets are incomplete. The calibrated model matches the high degree of comovement in idiosyncratic volatilities, the CIV-beta return spread, and several other asset price moments.

Number of Pages in PDF File: 60

Keywords: Firm volatility, Idiosyncratic risk, Cross-section of stock returns

JEL Classification: E3, E20, G1, L14, L25

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Date posted: November 12, 2012 ; Last revised: April 19, 2014

Suggested Citation

Herskovic, Bernard and Kelly, Bryan T. and Lustig, Hanno N. and Van Nieuwerburgh, Stijn, The Common Factor in Idiosyncratic Volatility: Quantitative Asset Pricing Implications (April 18, 2014). Fama-Miller Working Paper; Chicago Booth Research Paper No. 12-54. Available at SSRN: http://ssrn.com/abstract=2174541 or http://dx.doi.org/10.2139/ssrn.2174541

Contact Information

Bernard Herskovic
New York University (NYU) ( email )
19 W 4th Street, 6th FL
New York, NY 10012
United States
Bryan T. Kelly (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-8359 (Phone)
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Hanno N. Lustig
UCLA - Anderson School of Management ( email )
405 Hilgard Avenue
Box 951361
Los Angeles, CA 90095
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Stijn Van Nieuwerburgh
New York University Stern School of Business, Department of Finance ( email )
44 West 4th Street
Suite 9-190
New York, NY 10012-1126
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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