Idiosyncratic Volatility of Small Public Firms and Entrepreneurial Risk

58 Pages Posted: 21 Mar 2006

See all articles by David P. Brown

David P. Brown

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Miguel A. Ferreira

Nova School of Business and Economics; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Date Written: December 2005

Abstract

The average idiosyncratic volatility of small public firms is a positive predictor of future stock returns. This is true for returns of both large and small firms. We consider several economic arguments for this result, including a liquidity premium, and we rule out all but one of them. Our evidence supports the entrepreneurial risk hypothesis, which states that small firms' idiosyncratic risk is a proxy for risk faced by private business owners, who also happen to be significant shareholders of stock. Expected returns are increasing functions of entrepreneurial risk, and therefore returns are predictable using proxies for this risk, which include small-firm idiosyncratic volatility.

Keywords: Idiosyncratic risk, Entrepreneurial risk, Small firms

JEL Classification: G10, G12

Suggested Citation

Brown, David P. and Ferreira, Miguel Almeida, Idiosyncratic Volatility of Small Public Firms and Entrepreneurial Risk (December 2005). Available at SSRN: https://ssrn.com/abstract=892145 or http://dx.doi.org/10.2139/ssrn.892145

David P. Brown

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-265-5281 (Phone)
608-265-4195 (Fax)

Miguel Almeida Ferreira (Contact Author)

Nova School of Business and Economics ( email )

Campus de Campolide
Lisbon, 1099-032
Portugal

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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