Profitability Anomaly and Aggregate Volatility Risk
65 Pages Posted: 29 Nov 2015 Last revised: 25 Jan 2020
Date Written: January 23, 2020
Firms with lower profitability have lower expected returns because such firms perform better than expected when market volatility increases. The better-than-expected performance arises because unprofitable firms are distressed and volatile, their equity resembles a call option on the assets, and call options value increases with volatility, all else fixed. Consistent with this hypothesis, the profitability anomaly is stronger for distressed and volatile firms, and aggregate volatility risk can explain this regularity.
Keywords: profitability, aggregate volatility risk, distress, default, idiosyncratic volatility, anomalies
JEL Classification: G11, G12, E44, M41
Suggested Citation: Suggested Citation