Return Reversals, Idiosyncratic Risk, and Expected Returns

37 Pages Posted: 13 Jan 2009

See all articles by Wei Huang

Wei Huang

University of Hawaii at Manoa - Shidler College of Business

Qianqiu Liu

University of Hawaii at Manoa - Shidler College of Business

S. Ghon Rhee

University of Hawaii - Shidler College of Business; University of Hawaii - Department of Financial Economics and Institutions

Liang Zhang

University of Hawaii

Multiple version iconThere are 2 versions of this paper

Date Written: January 11, 2009

Abstract

The empirical evidence on the cross-sectional relation between idiosyncratic risk and expected stock returns is mixed. We demonstrate that the omission of the previous month's stock returns can lead to a negatively biased estimate of the relation. The magnitude of the omitted variable bias depends on the approach to estimating the conditional idiosyncratic volatility. Although a negative relation exists when the estimate is based on daily returns, it disappears after return reversals are controlled for. Return reversals can explain both the negative relation between value-weighted portfolio returns and idiosyncratic volatility and the insignificant relation between equal-weighted portfolio returns and idiosyncratic volatility. In contrast, there is a significantly positive relation between the conditional idiosyncratic volatility estimated from monthly data and expected returns. This relation remains robust after controlling for return reversals.

Keywords: return reversal, idiosyncratic risk, expected return

JEL Classification: G12, C13

Suggested Citation

Huang, Wei and Liu, Qianqiu and Rhee, S. Ghon and Zhang, Liang, Return Reversals, Idiosyncratic Risk, and Expected Returns (January 11, 2009). Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1326118

Wei Huang

University of Hawaii at Manoa - Shidler College of Business ( email )

2404 Maile Way
Honolulu, HI 96822
United States
808-956-7679 (Phone)
808-956-9887 (Fax)

Qianqiu Liu (Contact Author)

University of Hawaii at Manoa - Shidler College of Business ( email )

2404 Maile Way, E602f
Honolulu, HI 96822
United States
808-956-8736 (Phone)
808-956-9887 (Fax)

S. Ghon Rhee

University of Hawaii - Shidler College of Business ( email )

2404 Maile Way
C-304, FEI/CBA
Honolulu, HI 96822
United States

University of Hawaii - Department of Financial Economics and Institutions ( email )

United States

Liang Zhang

University of Hawaii ( email )

2404 Maile Way,
Honolulu, HI 96822
United States

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