Idiosyncratic Volatility and Firm-Specific News: Beyond Limited Arbitrage

Financial Management, Forthcoming

75 Pages Posted: 25 Sep 2015 Last revised: 12 Jul 2016

See all articles by Jared DeLisle

Jared DeLisle

Utah State University

Nathan Mauck

University of Missouri - Kansas City

Adam R Smedema

University of Northern Iowa

Date Written: September 23, 2015

Abstract

Recent evidence (Stambaugh, Yu, and Yuan, 2015) indicates that the most promising explanation for the negative price of idiosyncratic volatility is from its function as a limit arbitrage. Our evidence incorporating firm specific news is inconsistent with the limited arbitrage explanation. Since mispricing is most likely to occur during news announcements, the pricing of news volatility (volatility contemporaneous to news announcements) should be stronger than that of non-news volatility (volatility without an identified news announcement). We find the opposite. Non-news volatility has robust negative price and lacks some of the key features expected from the limited arbitrage explanation. We conclude that the pricing of idiosyncratic volatility is beyond its function as a limit of arbitrage. In addition, we consider evidence at odds with explanations based on difference of investor opinion and investor sentiment. Hence the pricing of idiosyncratic volatility is a deeper puzzle.

Keywords: Asset pricing; Empirical asset pricing; Idiosyncratic volatility

JEL Classification: G12; G14

Suggested Citation

DeLisle, Jared and Mauck, Nathan and Smedema, Adam R, Idiosyncratic Volatility and Firm-Specific News: Beyond Limited Arbitrage (September 23, 2015). Financial Management, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2664911 or http://dx.doi.org/10.2139/ssrn.2664911

Jared DeLisle

Utah State University ( email )

Logan, UT 84322
United States
435-797-0885 (Phone)

Nathan Mauck (Contact Author)

University of Missouri - Kansas City ( email )

5100 Rockhill Road
Kansas City, MO 64110-2499
United States

Adam R Smedema

University of Northern Iowa ( email )

Cedar Falls, IA 50614
United States

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