Advertisement

Review of Quantitative Finance and Accounting

, Volume 52, Issue 2, pp 381–401 | Cite as

Idiosyncratic volatility puzzle: influence of macro-finance factors

  • Nektarios Aslanidis
  • Charlotte ChristiansenEmail author
  • Neophytos Lambertides
  • Christos S. Savva
Original Research
  • 452 Downloads

Abstract

We analyze the cross-sectional relation between expected idiosyncratic volatility and stock returns. The expected idiosyncratic volatility is conditioned on macro-finance factors as well as traditional asset pricing factors. The macro-finance factors are constructed from a large set of macroeconomic and financial variables. Our results show that the negative relation between expected idiosyncratic volatility and stock returns reverses to a positive one when accounting for the macro-finance effects. Portfolio analysis shows that the positive relation is economically important. The relation between expected idiosyncratic volatility and returns is not affected by business cycle variations. The empirical results are highly robust.

Keywords

Idiosyncratic volatility puzzle Macro-finance factors Business cycle 

JEL Classification

G12 G14 

Notes

Acknowledgements

The authors are grateful for helpful comments from an anonymous referee as well as from seminar participants at Rady School of Management, University of California San Diego and at the Conference on Computational and Financial Econometrics (CFE 2015) in London. Aslanidis acknowledges support from the Spanish Ministry of Science and Innovation project grant (Reference No. ECO2013-42884-P). Christiansen acknowledges support from CREATES funded by the Danish National Research Foundation (DNRF78) and from the Danish Council for Independent Research, Social Sciences (DFF – 4003-00022).

References

  1. Ang A, Hodrick RJ, Xing Y, Zhang X (2006) The crosssection of volatility and expected returns. J Finance 61:259–299CrossRefGoogle Scholar
  2. Ang A, Hodrick RJ, Xing Y, Zhang X (2009) High idiosyncratic volatility and low returns: international and further US evidence. J Financ Econ 91(1):1–23CrossRefGoogle Scholar
  3. Baker SR, Bloom N, Davis SJ (2016) Measuring economic policy uncertainty. Q J Econ 131(4):1593–1636CrossRefGoogle Scholar
  4. Bali T, Cakici N (2008) Idiosyncratic volatility and the cross section of expected returns. J Financ Quant Anal 43(1):29–58CrossRefGoogle Scholar
  5. Bali TG, Zhou H (2016) Risk, uncertainty, and expected returns. J Financ Quant Anal 51(3):707–735CrossRefGoogle Scholar
  6. Bali T, Cakici N, Whitelaw R (2011) Maxing out: stocks as lotteries and the cross-section of expected returns. J Financ Econ 99:427–446CrossRefGoogle Scholar
  7. Binder JJ, Merges MJ (2001) Stock market volatility and economic factors. Rev Quant Financ Acc 17(1):5–26CrossRefGoogle Scholar
  8. Boyer B, Mitton T, Vorlink K (2010) Expected idiosyncratic skewness. Rev Financ Stud 23:169–202CrossRefGoogle Scholar
  9. Brandt MW, Brav A, Graham JR, Kumar A (2010) The idiosyncratic volatility puzzle: time trend or speculative episodes. Rev Financ Stud 23:863–899CrossRefGoogle Scholar
  10. Cakici N, Topyan K, Wang C-J (2014) Cross-sectional return predictability in Taiwan stock exchange: an empirical investigation. Rev Pac Basin Financ Markets Policies 17(02):1450010CrossRefGoogle Scholar
  11. Campbell JY, Lettau M, Malkiel BG, Xu Y (2001) Have individual stocks become more volatile? An empirical exploration of idiosyncratic risk. J Finance 56:1–43CrossRefGoogle Scholar
  12. Carhart MM (1997) On persistence in mutual fund performance. J Finance 52(1):57–82CrossRefGoogle Scholar
  13. Chen Z, Petkova P (2012) Does idiosyncratic volatility proxy for risk exposure. Rev Financ Stud 25(9):2745–2787CrossRefGoogle Scholar
  14. Fama E, French K (1992) The cross-section of expected stock returns. Rev Finance 47(2):427–465Google Scholar
  15. Fama E, French K (1993) Common risk factors in the returns on stocks and bonds. J Financ Econ 33:3–56CrossRefGoogle Scholar
  16. Fama E, MacBeth JD (1973) Risk, return, and equilibrium: empirical tests. J Polit Econ 71:607–636CrossRefGoogle Scholar
  17. Fink JD, Fink KE, He H (2012) Expected idiosyncratic volatility measures and expected returns. Financ Manag 41(3):519–553CrossRefGoogle Scholar
  18. Fu F (2009) Idiosyncratic risk and the cross-section of expected returns. J Financ Econ 91:24–37CrossRefGoogle Scholar
  19. Ghysels E, Plazzi A, Valkanov R (2013) The risk-return relationship and financial crises. Working Paper, UNCGoogle Scholar
  20. Goetzmann W, Kumar A (2008) Equity portfolio diversification. Rev Finance 12(3):433–463CrossRefGoogle Scholar
  21. Goyal A, Welch I (2008) A comprehensive look at the empirical performance of equity premium prediction. Rev Financ Stud 21(4):1455–1508CrossRefGoogle Scholar
  22. Guo H, Kassa H, Ferguson MF (2014) On the relation between EGARCH idiosyncratic volatility and expected stock returns. J Financ Quant Anal 49:271–296CrossRefGoogle Scholar
  23. Herskovic B, Kelly B, Lustig H, Nieuwerburgh SV (2016) The common factor in idiosyncratic volatility: quantitative asset pricing implications. J Financ Econ 119:249–283CrossRefGoogle Scholar
  24. Huang W, Liu Q, Rhee S, Zhang L (2010) Return reversals, idiosyncratic volatility, and expected returns. Rev Financ Stud 23(1):147–168CrossRefGoogle Scholar
  25. Hur J, Luma CM (2017) Aggregate idiosyncratic volatility, dynamic aspects of loss aversion, and narrow framing. Rev Quant Financ Acc 49(2):407–433CrossRefGoogle Scholar
  26. Ludvigson SC, Ng S (2007) The empirical risk-return relation: a factor analysis approach. J Financ Econ 83(1):171–222CrossRefGoogle Scholar
  27. Lustig H, Verdelhan A (2012) Business cycle variation in the risk-return trade-off. J Monet Econ 59:35–49CrossRefGoogle Scholar
  28. Merton RC (1987) Presidential address: a simple model of capital market equilibrium with incomplete information. J Finance 42:483–510CrossRefGoogle Scholar
  29. Newey WK, West KD (1987) A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica 55(3):703–708CrossRefGoogle Scholar
  30. Nyberg H (2012) Risk-return tradeoff in U.S. stock returns over the business cycle. J Financ Quant Anal 47(1):137–158CrossRefGoogle Scholar
  31. Pastor L, Stambaugh RF (2003) Liquidity risk and expected stock returns. J Polit Econ 111(3):642–685CrossRefGoogle Scholar
  32. Schwert GW (1989) Why does stock market volatility change over time? J Finance 44:1115–1153CrossRefGoogle Scholar
  33. Stambaugh RF, Yu J, Yuan Y (2015) Arbitrage asymmetry and the idiosyncratic volatility puzzle. J Finance 70:1903–1948CrossRefGoogle Scholar
  34. Vidal-García J, Vidal M, Nguyen DK (2016) Do liquidity and idiosyncratic risk matter? Evidence from the European mutual fund market. Rev Quant Financ Acc 47(2):213–247CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2018

Authors and Affiliations

  1. 1.Department d’Economia, CREIPUniversitat Rovira i VirgiliReus, CataloniaSpain
  2. 2.CREATES, Department of Economics and Business Economics, School of Business and Social SciencesAarhus UniversityAarhus VDenmark
  3. 3.Lund UniversityLundSweden
  4. 4.Department of Commerce, Finance and ShippingCyprus University of TechnologyLimassolCyprus

Personalised recommendations