Are Investors Compensated for the Unit Shocks of Idiosyncratic Volatility
Posted: 19 Jun 2017
Date Written: June 16, 2017
This study finds 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: Suggested Citation