Are Investors Compensated for the Unit Shocks of Idiosyncratic Volatility

Posted: 19 Jun 2017

See all articles by Haoxi Yang

Haoxi Yang

Nankai University

Yuecheng Jia

Central University of Finance and Economics (CUFE) - Chinese Academy of Finance and Development

Hongrui Feng

Pennsylvania State University

Date Written: June 16, 2017

Abstract

This study fi nds that a novel transformation of the idiosyncratic volatility (IVOL), the unit shocks of IVOL (US(IVOL)), has a strong negative relation with future stock returns even after controlling for IVOL itself and all major return predictors. We construct the US(IVOL) by scaling the excess IVOL (against the historical average IVOL) by the corresponding historical IVOL standard deviation. The return-predictive power of US(IVOL), on one hand, comes from its strong negative relation with future IVOL. On the other hand, US(IVOL) can predict stock returns because it represents the compensation for the arbitrage risk for short sellers.

Keywords: Idiosyncratic Volatility, Uncertainty of Arbitrage Risk

JEL Classification: G11, G12

Suggested Citation

Yang, Haoxi and Jia, Yuecheng and Feng, Hongrui, Are Investors Compensated for the Unit Shocks of Idiosyncratic Volatility (June 16, 2017). Available at SSRN: https://ssrn.com/abstract=2988124

Haoxi Yang (Contact Author)

Nankai University ( email )

Tongyan Road 38
Tianjin, Tianjin 300350
China

Yuecheng Jia

Central University of Finance and Economics (CUFE) - Chinese Academy of Finance and Development ( email )

39 South College Road
Beijing
China

Hongrui Feng

Pennsylvania State University ( email )

286 Burke
Erie, PA 16563
United States

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