Volatility and the Cross-Section of Equity Returns: Market Frictions vs. Arbitrage Risk

48 Pages Posted: 28 Apr 2020 Last revised: 8 Mar 2021

See all articles by Ruslan Goyenko

Ruslan Goyenko

McGill University - Desautels Faculty of Management

Paul Schultz

University of Notre Dame

Date Written: April 3, 2020

Abstract

IHS Markit data reveals that stocks with high idiosyncratic volatility are far more likely to be hard-to-borrow than low idiosyncratic volatility stocks. When hard-to-borrow stocks are excluded, the relation between idiosyncratic volatility (IVOL) and stock returns disappears. The relation between idiosyncratic volatility and returns is more accurately described as a relation between being hard-to-borrow and stock returns. Arbitrage risk, on the other hand, is far too small to explain mispricing of high IVOL stocks. When the idiosyncratic volatility of portfolios rather than individual stocks is considered, Sharpe ratios of mispriced IVOL portfolios are much greater than the value-weighted market’s Sharpe ratio.

Keywords: Short Selling Fees, Idiosyncratic Volatility, Hard to Borrow Stocks

Suggested Citation

Goyenko, Ruslan and Schultz, Paul, Volatility and the Cross-Section of Equity Returns: Market Frictions vs. Arbitrage Risk (April 3, 2020). Available at SSRN: https://ssrn.com/abstract=3567800 or http://dx.doi.org/10.2139/ssrn.3567800

Ruslan Goyenko (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

Paul Schultz

University of Notre Dame ( email )

361 Mendoza College of Business
Notre Dame, IN 46556-5646
United States

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