The Alphas of Beta and Idiosyncratic Volatility

46 Pages Posted: 15 Jun 2021

See all articles by Percy Poon

Percy Poon

University of Nevada, Las Vegas - Department of Finance

Tong Yao

University of Iowa - Henry B. Tippie College of Business

Andrew (Jianzhong) Zhang

University of Nevada, Las Vegas - Department of Finance

Date Written: Feburary 6, 2021

Abstract

We find that the relation between the idiosyncratic volatility (IVOL) anomaly and the beta anomaly is quite different at long horizons than at short horizons. IVOL has a significantly negative relation with subsequent stock returns at the short horizon of up to six months and beta does not predict stock returns at any horizon. However, both IVOL and beta significantly negatively predict stock alphas over horizons from a few months to beyond one year. At short horizons, neither anomaly can fully explain the other. At long horizons of beyond six months, the IVOL-alpha relation is explained by the beta-alpha relation. A measure of idiosyncratic volatility over a long window, popularly used by the investments industry to construct low-volatility portfolios, behaves similarly to beta in predicting returns and alphas at various horizons, and its predictive power is mostly explained by beta. Overall, IVOL and beta each has unique short-term information, but at long horizons the two anomalies appear to be the same. Our findings help reconcile a perceptional gap between academic studies and the investment industry on low volatility investing, and enrich the debate about the relation between the two low-risk anomalies.

Keywords: Beta anomaly, Idiosyncratic volatility anomaly, alpha

JEL Classification: G11, G12

Suggested Citation

Poon, Percy and Yao, Tong and Zhang, Andrew (Jianzhong), The Alphas of Beta and Idiosyncratic Volatility (Feburary 6, 2021). Available at SSRN: https://ssrn.com/abstract=3706597 or http://dx.doi.org/10.2139/ssrn.3706597

Percy Poon

University of Nevada, Las Vegas - Department of Finance ( email )

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Tong Yao

University of Iowa - Henry B. Tippie College of Business ( email )

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Andrew (Jianzhong) Zhang (Contact Author)

University of Nevada, Las Vegas - Department of Finance ( email )

4505 S. Maryland Parkway
Box 456008
Las Vegas, NV 89154-6008
United States

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