Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle

58 Pages Posted: 2 Oct 2012 Last revised: 2 Sep 2020

See all articles by Robert F. Stambaugh

Robert F. Stambaugh

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Jianfeng Yu

Tsinghua University - PBC School of Finance

Yu Yuan

Shanghai Mingshi Investment Company; University of Pennsylvania - Wharton Financial Institutions Center

Multiple version iconThere are 2 versions of this paper

Date Written: October 12, 2014

Abstract

Many investors purchase stock but are reluctant or unable to sell short. Combining this arbitrage asymmetry with the arbitrage risk represented by idiosyncratic volatility (IVOL) explains the negative relation between IVOL and average return. The IVOL-return relation is negative among overpriced stocks but positive among underpriced stocks, with mispricing determined by combining 11 return anomalies. Consistent with arbitrage asymmetry, the negative relation among overpriced stocks is stronger, especially for stocks less easily shorted, so the overall IVOL-return relation is negative. Further supporting our explanation, high investor sentiment weakens the positive relation among underpriced stocks and, especially, strengthens the negative relation among overpriced stocks.

Keywords: arbitrage risk, idiosyncratic volatility puzzle, short-sale constraints, investor sentiment

Suggested Citation

Stambaugh, Robert F. and Yu, Jianfeng and Yuan, Yu, Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle (October 12, 2014). Journal of Finance, Vol 70, pp 1903-1948, 2015, Jacobs Levy Equity Management Center for Quantitative Financial Research Paper , Available at SSRN: https://ssrn.com/abstract=2155491 or http://dx.doi.org/10.2139/ssrn.2155491

Robert F. Stambaugh

University of Pennsylvania - The Wharton School ( email )

The Wharton School, Finance Department
University of Pennsylvania
Philadelphia, PA 19104-6367
United States
215-898-5734 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jianfeng Yu

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing 100083
China

Yu Yuan (Contact Author)

Shanghai Mingshi Investment Company ( email )

488 M Yincheng Road
Shanghai
China

University of Pennsylvania - Wharton Financial Institutions Center

3733 Spruce Street
Philadelphia, PA 19104-6374
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
3,871
Abstract Views
21,663
Rank
5,033
PlumX Metrics