The Idiosyncratic Volatility Anomaly and the Resale Option in Chinese Stock Markets

42 Pages Posted: 21 Nov 2018 Last revised: 29 Nov 2018

See all articles by Zhiguang Cao

Zhiguang Cao

Shanghai University of Finance and Economics - Department of Finance

Stephen Satchell

The University of Sydney

P. Joakim Westerholm

University of Sydney Business School; Financial Research Network (FIRN)

Henry Zhang

The University of Sydney, Business School, Discipline of Finance

Date Written: November 20, 2018

Abstract

The well-documented negative association between idiosyncratic volatility (IV) and stock returns is puzzling if investors are risk-averse. We show that this anomaly is also prominent in the Chinese stock market. We attempt to explain the IV anomaly by using the key theories suggested by the literature, such as the lottery effect, arbitrage asymmetry, prospect theory, return reversals and more. None of these competing theories is able to justify the IV anomaly in China. Given that the Chinese stock market possesses both short selling constraints and heterogeneous beliefs, we employ resale option theory as a way to explain the IV puzzle. We find that the resale option value is consistently related to the IV effect in China, and that the explanatory power of the resale option value for the IV anomaly survives a range of robustness tests.

Keywords: Idiosyncratic Volatility, Resale Option, China

JEL Classification: G11, G12

Suggested Citation

Cao, Zhiguang and Satchell, Stephen and Westerholm, P. Joakim and Zhang, Hui Henry, The Idiosyncratic Volatility Anomaly and the Resale Option in Chinese Stock Markets (November 20, 2018). Available at SSRN: https://ssrn.com/abstract=3274652 or http://dx.doi.org/10.2139/ssrn.3274652

Zhiguang Cao (Contact Author)

Shanghai University of Finance and Economics - Department of Finance ( email )

Shanghai, 200433
China

Stephen Satchell

The University of Sydney ( email )

University of Sydney
Sydney, NSW 2006
Australia

P. Joakim Westerholm

University of Sydney Business School ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Hui Henry Zhang

The University of Sydney, Business School, Discipline of Finance ( email )

P.O. Box H58
Sydney, NSW 2006
Australia

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