On the Relation between EGARCH Idiosyncratic Volatility and Expected Stock Returns
50 Pages Posted: 18 Aug 2010 Last revised: 3 Jun 2014
Date Written: July 2012
A spurious positive relation between EGARCH estimates of expected month t idiosyncratic volatility and month t stock returns arises when the month t return is included in the estimation of model parameters. We illustrate via simulations that this look-ahead bias is problematic for empirically observed degrees of stock return skewness and typical monthly return time series lengths. Moreover, the empirical idiosyncratic-return relation becomes negligible when expected month t idiosyncratic volatility is estimated using returns only upto month t-1.
Keywords: EGARCH, idiosyncratic volatility, cross-section of stock returns
JEL Classification: G1
Suggested Citation: Suggested Citation