Trend and Reversal of Idiosyncratic Volatility Revisited

Critical Finance Review

57 Pages Posted: 14 Feb 2019 Last revised: 3 Nov 2020

See all articles by Markus Leippold

Markus Leippold

University of Zurich; Swiss Finance Institute

Michal Svaton

University of Zurich - Department of Banking and Finance

Date Written: March 25, 2019

Abstract

We reexamine the evolution of the idiosyncratic volatility (IV) of US firms between 1962 and 2016. We theoretically identify three fundamental drivers for the IV: market concentration, average variance, and average correlation. Exploring the separate impacts of these drivers on IV, we find that most of the increase in IV between 1960 and 2000 documented in earlier studies is a result of microstructural biases contained in the daily returns. Consequently, the subsequent introduction of quote decimalization in 2001 caused the reversal of IV. We conclude that studies analyzing volatilities and correlations using daily data from before 2001 should be carefully revisited.

Keywords: Idiosyncratic Volatility, Measurement Error, Bid-Ask Bounce, Asynchronicity

JEL Classification: G11, G12, G14

Suggested Citation

Leippold, Markus and Svaton, Michal, Trend and Reversal of Idiosyncratic Volatility Revisited (March 25, 2019). Critical Finance Review, Available at SSRN: https://ssrn.com/abstract=3321678 or http://dx.doi.org/10.2139/ssrn.3321678

Markus Leippold (Contact Author)

University of Zurich ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Michal Svaton

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

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