The Idiosyncratic Volatility Puzzle and its Interplay with Sophisticated and Private Investors

50 Pages Posted: 28 Feb 2018 Last revised: 27 Jul 2018

See all articles by Hannes Mohrschladt

Hannes Mohrschladt

University of Muenster - Finance Center

Judith C. Schneider

University of Muenster - Finance Center Muenster

Date Written: July 17, 2018

Abstract

We establish a direct link between the idiosyncratic volatility (IVol) puzzle and the behavior of sophisticated and private investors. To do so, we employ three option-based measures of informed trading and attention data from Google Trends. Our analyses show that the IVol puzzle is particularly driven by a group of overpriced stocks that can be identified by the use of sophisticated trader opinion. Since IVol is no perfect mispricing indicator, the option measures can help to distinguish high-IVol stocks that are overvalued from high-IVol stocks that are not exposed to mispricing. We link the origin of the anomaly to the trading activity of irrational private investors. This supports the intuitive idea that noise trading leads to mispricing which can be exploited by sophisticated investors at the option market.

Keywords: Demand-Based Option Pricing, Idiosyncratic Volatility, Investor Attention

JEL Classification: G12, G14, G40

Suggested Citation

Mohrschladt, Hannes and Schneider, Judith C., The Idiosyncratic Volatility Puzzle and its Interplay with Sophisticated and Private Investors (July 17, 2018). Available at SSRN: https://ssrn.com/abstract=3131703 or http://dx.doi.org/10.2139/ssrn.3131703

Hannes Mohrschladt (Contact Author)

University of Muenster - Finance Center ( email )

Universit├Ątsstr. 14-16
Muenster, 48143
Germany

HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/en/the-fcm/lsf/team/hannes-mohrschladt

Judith C. Schneider

University of Muenster - Finance Center Muenster ( email )

Universitatsstr. 14-16
Muenster, 48143
Germany

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