The Information Content of Idiosyncratic Volatility

Journal of Financial and Quantitative Analysis, 2009, 44(1), 1-28.

28 Pages Posted: 18 Aug 2005 Last revised: 3 Oct 2012

George J. Jiang

Washington State University

Danielle Xu

Gonzaga University

Tong Yao

University of Iowa - Henry B. Tippie College of Business

Date Written: June 1, 2009

Abstract

This paper uses adverse selection in corporate information disclosure to explain a recently documented asset pricing anomaly. Ang, Hodrick, Xing, and Zhang (2006a) show that stocks with high idiosyncratic return volatilities tend to have low future returns. In this paper, we find that idiosyncratic volatility is also inversely related to future earning shocks. More importantly, we show that the return predictive power of idiosyncratic volatility is induced by its information content on future earnings. We provide empirical results to support our explanation that firms with poor prospect of future earnings tend to disclose less information, resulting in a higher degree of heterogeneity in investors beliefs, which in turn leads to higher stock return volatility and trading volume. Further analysis suggests that investors tend to underreact to earnings information in idiosyncratic volatility, and the mispricing of idiosyncratic volatility is inversely related to both investor sophistication and stock liquidity.

Keywords: Idiosyncratic Volatility, Corporate Disclosure

JEL Classification: G12, G14

Suggested Citation

Jiang, George J. and Xu, Danielle and Yao, Tong, The Information Content of Idiosyncratic Volatility (June 1, 2009). Journal of Financial and Quantitative Analysis, 2009, 44(1), 1-28.. Available at SSRN: https://ssrn.com/abstract=783284 or http://dx.doi.org/10.2139/ssrn.783284

George Jiang

Washington State University ( email )

Department of Finance and Management Science
Carson College of Business
Pullman, WA 99-4746164
United States
509-3354474 (Phone)

HOME PAGE: http://directory.business.wsu.edu/bio.html?username=george.jiang

Danielle Xu

Gonzaga University ( email )

Spokane, WA 99258
United States

Tong Yao (Contact Author)

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

Acquisitions
5020 Main Library
Iowa City, IA 52242-1000
United States

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