Hedge Funds and the Positive Idiosyncratic Volatility Effect

59 Pages Posted: 12 Dec 2018 Last revised: 18 Jul 2023

See all articles by Turan G. Bali

Turan G. Bali

Georgetown University - McDonough School of Business

Florian Weigert

University of Neuchatel - Institute of Financial Analysis; University of Cologne - Centre for Financial Research (CFR)

Date Written: July 17, 2023

Abstract

While it is established that idiosyncratic volatility has a negative impact on the cross-section of stock returns, this relation is largely unexplored for hedge funds. We document that hedge funds with high idiosyncratic volatility earn higher future risk-adjusted returns of 6% p.a. than hedge funds with low idiosyncratic volatility. The outperformance arises because hedge funds trade high idiosyncratic volatility stocks wisely. They pick high volatility stocks when they are underpriced and short-sell high volatility stocks when they are overpriced. Our results support the notion that hedge funds’ idiosyncratic volatility is a measure of managerial skill.

Keywords: Hedge Funds, Idiosyncratic Volatility Puzzle, Equity Portfolio Holdings, Short-Selling, Managerial Incentives, Investment Performance

JEL Classification: G11, G23

Suggested Citation

Bali, Turan G. and Weigert, Florian, Hedge Funds and the Positive Idiosyncratic Volatility Effect (July 17, 2023). Georgetown McDonough School of Business Research Paper No. 3292347, University of St.Gallen, School of Finance Research Paper, Available at SSRN: https://ssrn.com/abstract=3292347 or http://dx.doi.org/10.2139/ssrn.3292347

Turan G. Bali

Georgetown University - McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States
(202) 687-5388 (Phone)
(202) 687-4031 (Fax)

HOME PAGE: https://sites.google.com/a/georgetown.edu/turan-bali

Florian Weigert (Contact Author)

University of Neuchatel - Institute of Financial Analysis ( email )

Pierre-a-Mazel,7
Neuchatel, CH-2000
Switzerland

University of Cologne - Centre for Financial Research (CFR) ( email )

Albertus-Magnus Platz
Cologne, 50923
Germany

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