Long-Run Idiosyncratic Volatilities and Cross-Sectional Stock Returns
47 Pages Posted: 15 Mar 2010
Date Written: February 28, 2010
Abstract
This paper reconciles the conflicting evidence on the cross-sectional pricing of idiosyncratic risk. Some studies find a negative relation, while others document a positive relation between idiosyncratic volatilities and future returns on individual stocks. In contrast to the common practice of applying total idiosyncratic volatilities, we decompose the volatility into long- and short-run components. As a result, we find that stocks with high long-run idiosyncratic risks have large future returns. On the contrary, the short-run idiosyncratic risk component is negatively related to stock returns. This finding suggests that different relations documented in the current literature depend on the dominance of the long- versus the short-run components of the idiosyncratic risk reflected in the particular measure used by a study. Our results are robust to model specifications, sample periods, different samples of stocks, and the possible January effect.
Keywords: APT model, Cross-sectional returns, Decomposition, Error-in-variables, Idiosyncratic risk, January effect, Long-run volatility, Short-run volatility
JEL Classification: G12
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
The Cross-Section of Volatility and Expected Returns
By Andrew Ang, Robert J. Hodrick, ...
-
The Cross-Section of Volatility and Expected Returns
By Andrew Ang, Robert J. Hodrick, ...
-
By Amit Goyal and Pedro Santa-clara
-
Stocks as Lotteries: the Implications of Probability Weighting for Security Prices
By Nicholas Barberis and Ming Huang
-
Stocks as Lotteries: The Implications of Probability Weighting for Security Prices
By Nicholas Barberis and Ming Huang
-
Equity Portfolio Diversification
By Alok Kumar and William N. Goetzmann
-
Equity Portfolio Diversification
By Alok Kumar and William N. Goetzmann
-
Idiosyncratic Risk and Security Returns
By Yexiao Xu and Burton G. Malkiel
-
High Idiosyncratic Volatility and Low Returns: International and Further U.S. Evidence
By Andrew Ang, Robert J. Hodrick, ...
-
High Idiosyncratic Volatility and Low Returns: International and Further U.S. Evidence
By Xiaoyan Zhang, Andrew Ang, ...