Incomplete Information, Idiosyncratic Volatility and Stock Returns
60 Pages Posted: 7 Sep 2008 Last revised: 5 Jul 2012
Date Written: December 12, 2011
When investors have incomplete information, expected returns, as measured by an econometrician, deviate from those predicted by standard asset pricing models by including a term that is the product of the stock's idiosyncratic volatility and the investors' aggregated forecast errors. If investors are biased this term generates a relation between idiosyncratic volatility and expected stocks returns. Relying on forecast revisions from IBES, we construct a new variable that proxies for this term and show that it explains a signicant part of the empirical relation between idiosyncratic volatility and stock returns.
Keywords: Idiosyncratic volatility, incomplete information, cross-section of stock returns.
JEL Classification: G12, D83, D92
Suggested Citation: Suggested Citation