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
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: Suggested Citation