Time Horizon Trading and the Idiosyncratic Risk Puzzle

37 Pages Posted: 22 Jul 2011 Last revised: 13 Apr 2013

Juliana Malagon

Universidad de los Andes, Colombia - School of Business Administration

David Moreno

Universidad Carlos III de Madrid - Department of Business Administration

Rosa Rodríguez

Universidad Carlos III de Madrid - Department of Business Administration

Date Written: November 1, 2011

Abstract

We analyze whether the idiosyncratic risk puzzle noted by Ang et al. (2006, 2009) can be explained by the existence of market participants with different investment horizons. We adopt a wavelet multiresolution analysis to decompose returns distribution for different time scales. Our approach divides the nonlinear link between expected returns and idiosyncratic risk into two linear relationships, a positive one for long-run investors and a negative one for short-run investors, indicating that the puzzle disappears as the wavelet scale increases (long-term horizons). Our results are robust to several types of wavelets, to different definitions of short-term investors and to various measures of idiosyncratic risk.

Keywords: idiosyncratic risk, wavelets, time-scaling risk

JEL Classification: G12

Suggested Citation

Malagon, Juliana and Moreno, David and Rodríguez, Rosa, Time Horizon Trading and the Idiosyncratic Risk Puzzle (November 1, 2011). Midwest Finance Association 2012 Annual Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1891985 or http://dx.doi.org/10.2139/ssrn.1891985

Juliana Malagon (Contact Author)

Universidad de los Andes, Colombia - School of Business Administration ( email )

Bogota
Colombia

David Moreno

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain

Rosa Rodriguez

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain

HOME PAGE: http://www.business.uc3m.es/en/faculty/profesor/perfil/42

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