Idiosyncratic Volatility, Its Expected Variation, and the Cross-Section of Stock Returns

61 Pages Posted: 1 Jul 2017 Last revised: 19 Jul 2019

See all articles by Nicole Branger

Nicole Branger

University of Muenster - Finance Center Muenster

Hendrik Hülsbusch

University of Muenster - Finance Center Muenster

T. Frederik Middelhoff

University of Muenster - Finance Center Muenster

Date Written: January 29, 2018

Abstract

We show that the widely documented negative relation between idiosyncratic volatility (IVOL) and expected returns can be explained by the mean reversion of stocks' idiosyncratic volatilities. We use option-implied information to extract the mean reversion speed of IVOL in an almost model-free fashion. This allows us to identify stocks for which past IVOL is a bad proxy for expected IVOL. These stocks solely drive the negative relation, and a long--short portfolio earns a monthly risk-adjusted return of 2.74%, on average. In a horse race, the mean reversion speed is superior to prominent competing explanations of the IVOL puzzle.

Keywords: Options, Stock Returns, Idiosyncratic Volatility, Volatility-of-Volatility

JEL Classification: G12, G13

Suggested Citation

Branger, Nicole and Hülsbusch, Hendrik and Middelhoff, Frederik T., Idiosyncratic Volatility, Its Expected Variation, and the Cross-Section of Stock Returns (January 29, 2018). Paris December 2018 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=2995069 or http://dx.doi.org/10.2139/ssrn.2995069

Nicole Branger

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 29779 (Phone)
+49 251 83 22867 (Fax)

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/fcm/das-finance-center/details.php?weobjectID=162

Hendrik Hülsbusch

University of Muenster - Finance Center Muenster ( email )

Schlossplatz 2
Muenster
Germany

Frederik T. Middelhoff (Contact Author)

University of Muenster - Finance Center Muenster ( email )

Schlossplatz 2
Muenster
Germany

Register to save articles to
your library

Register

Paper statistics

Downloads
428
Abstract Views
1,420
rank
66,860
PlumX Metrics