Is Idiosyncratic Volatility Related to Returns? Evidence from a Subset of Firms with Quality Idiosyncratic Volatility Estimates

40 Pages Posted: 5 Mar 2018 Last revised: 25 Mar 2018

Date Written: March 12, 2018

Abstract

Empirical studies investigating the relation between expected idiosyncratic volatility (IVOL) and returns find mixed results. Several papers report a negative relation using lagged realized IVOL to proxy for expectations, but Fu (2009) questions the validity of this proxy and proposes using forecasts from EGARCH models, resulting in a positive relation. However, recent studies show that this positive relation disappears when the forecasts are generated by out-of-sample models. We show that the proxies used in prior literature are noisy and propose using combinations of outof-sample IVOL forecasts that pass basic diagnostic tests. These high quality proxies uncover a significant positive relation.

Keywords: Idiosyncratic Volatility, Priced Risk Factors, GARCH, EGARCH, Conditional Expected Volatility

JEL Classification: G11, G12, G14

Suggested Citation

Bergbrant, Mikael C. and Kassa, Haim, Is Idiosyncratic Volatility Related to Returns? Evidence from a Subset of Firms with Quality Idiosyncratic Volatility Estimates (March 12, 2018). Available at SSRN: https://ssrn.com/abstract=3128867 or http://dx.doi.org/10.2139/ssrn.3128867

Mikael C. Bergbrant

St. Johns University ( email )

8000 Utopia Parkway
Queens, NY 11439
United States
8134476288 (Phone)

HOME PAGE: http://www.bergbrant.com

Haim Kassa (Contact Author)

Miami University ( email )

800 E. Main St
The Farmer School of Business
Oxford, OH 45056
United States
(513) 529-2057 (Phone)
(513) 556-4891 (Fax)

HOME PAGE: http://fsb.miamioh.edu/kassah

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