Dissecting the Idiosyncratic Volatility Anomaly

Abstract

The idiosyncratic volatility (IVOL) anomaly, documented in Ang, Hodrick, Xing, and Zhang (2006), has garnered a great deal of attention in the literature. Yet, questions remain regarding the robustness and pervasiveness of the IVOL anomaly, with a particular concern that the IVOL anomaly might simply be the manifestation of market microstructure effect. In this paper, we show that the IVOL anomaly is strong and pervasive after we exclude stocks most susceptible to market microstructure noise – such as microcap stocks, penny stocks, and stocks with strong short-term return reversal. These results are robust to equal-weighting or value-weighting stocks in the IVOL portfolios. Our findings suggest that rather than being the cause of the anomaly, market microstructure noise actually weakens the IVOL anomaly.

Keywords: Idiosyncratic volatility anomaly, Robustness, Market microstructure effect, Microcaps, Penny stocks, Stock return reversal

JEL Classification: G12, G14