Time Horizon Trading and the Idiosyncratic Risk Puzzle
37 Pages Posted: 22 Jul 2011 Last revised: 13 Apr 2013
Date Written: November 1, 2011
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: Suggested Citation