Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle

35 Pages Posted: 22 Nov 2012

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

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Date Written: November 2012

Abstract

Short selling, as compared to purchasing, faces greater risks and other potential impediments. This arbitrage asymmetry explains the negative relation between idiosyncratic volatility (IVOL) and average return. The IVOL effect is negative among overpriced stocks but positive among underpriced stocks, with mispricing determined by combining 11 return anomalies. The negative effect is stronger, consistent with asymmetry in risks and other impediments inhibiting arbitrageurs in exploiting overpricing. Aggregating across all stocks therefore yields a negative relation, explaining the IVOL puzzle. Further supporting our explanation is a negative relation over time between the IVOL effect and investor sentiment, especially among overpriced stocks.

Suggested Citation

Stambaugh, Robert F. and Yu, Jianfeng and Yuan, Yu, Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle (November 2012). NBER Working Paper No. w18560. Available at SSRN: https://ssrn.com/abstract=2179398

Robert F. Stambaugh (Contact Author)

University of Pennsylvania - The Wharton School ( email )

The Wharton School, Finance Department
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Jianfeng Yu

Tsinghua University - PBC School of Finance ( email )

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China

Yu Yuan

Shanghai Mingshi Investment Company ( email )

488 M Yincheng Road
Shanghai
China

University of Pennsylvania - Wharton Financial Institutions Center

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Philadelphia, PA 19104-6374
United States

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