Idiosyncratic Return Volatility in the Cross-Section of Stocks

49 Pages Posted: 18 Apr 2011

See all articles by Namho Kang

Namho Kang

Bentley University - Department of Finance

Peter Kondor

London School of Economics & Political Science (LSE); Central European University (CEU)

Ronnie Sadka

Boston College - Carroll School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: April 2011

Abstract

This paper uncovers the changes in the cross-sectional distribution of idiosyncratic volatility of stocks over the period 1963--2008. The contribution of the top decile to the total market idiosyncratic volatility increased, while the contribution of the bottom decile decreased. We introduce a simple theoretical model showing that larger capital of Long/Short-Equity funds further exacerbates large idiosyncratic shocks but attenuates small idiosyncratic shocks. This effect is stronger for more illiquid stocks. Time-series and cross-sectional results are consistent with the predictions of the model. The results are robust to industry affiliation, stock liquidity, firm size, firm leverage, as well as sign of price change. These findings highlight the roll of hedge funds and other institutional investors in explaining the dynamics of extreme realizations in the cross-section of returns.

Keywords: Hedge funds, idiosyncratic risk, limits to arbitrage

JEL Classification: G11, G12

Suggested Citation

Kang, Namho and Kondor, Peter and Sadka, Ronnie, Idiosyncratic Return Volatility in the Cross-Section of Stocks (April 2011). CEPR Discussion Paper No. DP8307, Available at SSRN: https://ssrn.com/abstract=1810272

Namho Kang (Contact Author)

Bentley University - Department of Finance ( email )

175 Forest Street
Waltham, MA 02154
United States

Peter Kondor

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://fmg.lse.ac.uk/~kondor

Central European University (CEU) ( email )

Nador utca 9
Budapest, H-1051
Hungary

Ronnie Sadka

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

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