Idiosyncratic Volatility: An Indicator of Noise Trading?

45 Pages Posted: 21 Mar 2007 Last revised: 12 Jun 2016

See all articles by Tom Aabo

Tom Aabo

Aarhus University

Christos Pantzalis

University of South Florida

Jung Chul Park

University of South Florida

Date Written: March 14, 2007


We investigate the market efficiency implications of firm-specific return variation measured by absolute idiosyncratic volatility. We find that the absolute idiosyncratic volatility (the variance of the residual from an asset-pricing model) displays a positive and robust relationship to mispricing (based on both accounting information and alternatively abnormal stock returns). Thus, we find that larger values of absolute idiosyncratic volatility reflect an increasing role of noise traders. Previous literature has produced similar - or opposing - results. We deepen our understanding of the reasons for the lack of consensus in the previous literature by investigating the interaction between market volatility, idiosyncratic volatility, and R-squared. Thus, we show that 1) market volatility by itself is associated with mispricing, 2) absolute idiosyncratic volatility is associated with mispricing even when controlling for market volatility, 3) the strength of the association between absolute idiosyncratic volatility and mispricing depends on the level of market volatility, and 4) absolute and relative measures of idiosyncratic volatility have opposing associations with mispricing.

Keywords: Idiosyncratic volatility, Market volatility, Equity mispricing, Market efficiency

JEL Classification: G12, G14

Suggested Citation

Aabo, Tom and Pantzalis, Christos and Park, Jung Chul, Idiosyncratic Volatility: An Indicator of Noise Trading? (March 14, 2007). Available at SSRN: or

Tom Aabo

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus
+45 87 16 48 39 (Phone)
+45 86 15 01 88 (Fax)

Christos Pantzalis

University of South Florida ( email )

Tampa, FL 33620-5500
United States
(813) 974-3262 (Phone)

Jung Chul Park (Contact Author)

University of South Florida ( email )

Tampa, FL 33620
United States
813-974-9680 (Phone)
813-974-3084 (Fax)


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