Hostname: page-component-8448b6f56d-xtgtn Total loading time: 0 Render date: 2024-04-19T02:58:07.357Z Has data issue: false hasContentIssue false
  • English
  • Français

Idiosyncratic Volatility and the Cross Section of Expected Returns

Published online by Cambridge University Press:  06 April 2009

Turan G. Bali  and
Nusret Cakici
Turan G. Bali
Affiliation:
turan_bali@baruch.cuny.edu, Department of Economics and Finance, Baruch College, Zicklin School of Business, City University of New York, One Bernard Baruch Way, Box 10-225, New York, NY 10010 and College of Administrative Sciences and Economics, Koc University, Rumeli Feneri Yolu, Istanbul, Turkey 34450
Nusret Cakici
Affiliation:
ncakici@asu.edu, Department of Economics and Finance, School of Global Management, Arizona State University, PO Box 37100, Phoenix, AZ 85069.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper examines the cross-sectional relation between idiosyncratic volatility and expected stock returns. The results indicate that i) the data frequency used to estimate idiosyncratic volatility, ii) the weighting scheme used to compute average portfolio returns, iii) the breakpoints utilized to sort stocks into quintile portfolios, and iv) using a screen for size, price, and liquidity play critical roles in determining the existence and significance of a relation between idiosyncratic risk and the cross section of expected returns. Portfoliolevel analyses based on two different measures of idiosyncratic volatility (estimated using daily and monthly data), three weighting schemes (value-weighted, equal-weighted, inverse volatility-weighted), three breakpoints (CRSP, NYSE, equal market share), and two different samples (NYSE/AMEX/NASDAQ and NYSE) indicate that no robustly significant relation exists between idiosyncratic volatility and expected returns.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 43 , Issue 1 , March 2008 , pp. 29 - 58
Copyright
Copyright © School of Business Administration, University of Washington 2008

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Amihud, Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.CrossRefGoogle Scholar
Ang, A.; Hodrick, R. J.; Xing, Y.; and Zhang, X.. “The Cross-Section of Volatility and Expected Returns.” Journal of Finance, 61 (2006), 259–299.CrossRefGoogle Scholar
Bali, T. G. “Testing the Empirical Performance of Stochastic Volatility Models of the Short-Term Interest Rate.” Journal of Financial and Quantitative Analysis, 35 (2000), 191–215.CrossRefGoogle Scholar
Bali, T. G.; Cakici, N.; Yan, X.; and Zhang, Z.. “Does Idiosyncratic Risk Really Matter?” Journal of Finance, 60 (2005), 905–929.CrossRefGoogle Scholar
Bessembinder, H. “Systematic Risk, Hedging Pressure, and Risk Premiums in Futures Markets.” Review of Financial Studies, 5 (1992), 637–667.CrossRefGoogle Scholar
Black, F. “Capital Market Equilibrium with Restricted Borrowing.” Journal of Business, 45 (1972), 444–455.CrossRefGoogle Scholar
Bollerslev, T. “Generalized Autoregressive Conditional Heteroscedasticity.” Journal of Econometrics, 31 (1986), 307–327.CrossRefGoogle Scholar
Campbell, J. Y.; Lettau, M.; Malkiel, B. G.; and Xu, Y.. “Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk.” Journal of Finance, 56 (2001), 1–43.CrossRefGoogle Scholar
Cohen, R. B., and Polk, C. K.. “The Impact of Industry Factors in Asset-Pricing Tests.” Working Paper, Harvard University (1998).Google Scholar
Douglas, G. W. “Risk in the Equity Markets: An Empirical Appraisal of Market Efficiency.” Yale Economic Essays, 9 (1969), 3–45.Google Scholar
Falkenstein, E. G. “Preferences for Stock Characteristics as Revealed by Mutual Fund Portfolio Holdings.” Journal of Finance, 51 (1996), 111–135.CrossRefGoogle Scholar
Fama, E. F., and French, K.. “Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.Google Scholar
Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.Google Scholar
Fama, E. F., and French, K.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E. F., and MacBeth, J. D.. “Risk and Return: Some Empirical Tests.” Journal of Political Economy, 81 (1973), 607–636.CrossRefGoogle Scholar
Fu, F. “Idiosyncratic Risk and the Cross-Section of Expected Stock Returns.” Working Paper, University of Rochester (2005).Google Scholar
Green, R. C., and Rydqvist, K.. “The Valuation of Nonsystematic Risks and the Pricing of Swedish Lottery Bonds.” Review of Financial Studies, 10 (1997), 447–480.CrossRefGoogle Scholar
Harris, L. E. “Minimum Price Variation, Discrete Bid-Ask Spreads, and Quotation Sizes.” Review of Financial Studies, 7 (1994), 149–178.CrossRefGoogle Scholar
Jegadeesh, N., and Titman, S.. “Profitability of Momentum Strategies: An Evaluation of Alternative Explanations.” Journal of Finance, 56 (2001), 699–720.CrossRefGoogle Scholar
Jones, C. M., and Rhodes-Kropf, M.. “The Price of Diversifiable Risk in Venture Capital and Private Equity.” Working Paper, Columbia University (2003).Google Scholar
King, M.; Sentana, E.; and Wadhwani, S.. “Volatility and Links between National Stock Markets.” Econometrica, 47 (1994), 263–291.Google Scholar
Kyle, A. “Continuous Auctions and Insider Trading.” Econometrica, 53 (1985), 1315–1335.CrossRefGoogle Scholar
Lehmann, B. N. “Residual Risk Revisited.” Journal of Econometrics, 45 (1990), 71–97.CrossRefGoogle Scholar
Levy, H. “Equilibrium in an Imperfect Market: A Constraint on the Number of Securities in the Portfolio.” American Economic Review, 68 (1978), 643–658.Google Scholar
Lintner, J. “The Valuation of Risky Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets.” Review of Economics and Statistics, 47 (1965a), 13–37.CrossRefGoogle Scholar
Lintner, J. “Security Prices, Risk and Maximal Gains from Diversification.” Journal of Finance, 20 (1965b), 587–615.Google Scholar
Malkiel, B. G., and Xu, Y.. “Risk and Return Revisited.” Journal of Portfolio Management, 24 (1997), 9–14.CrossRefGoogle Scholar
Malkiel, B. G., and Xu, Y.. “Idiosyncratic Risk and Security Returns.” Working Paper, University of Texas at Dallas ( 2002).Google Scholar
Markowitz, H.Portfolio Selection: Efficient Diversification of Investments. New York: Wiley (1959).Google Scholar
Merton, R. C. “A Simple Model of Capital Market Equilibrium with Incomplete Information.” Journal of Finance, 42 (1987), 483–510.CrossRefGoogle Scholar
Miller, M. H., and Scholes, M.. “Rates of Return in Relation to Risk: A Re-Examination of Some Recent Findings.” In Studies in the Theory of Capital Markets, Jensen, M. C., ed. New York: Praeger (1972).Google Scholar
Nelson, D. B. “Conditional Heteroskedasticity in Asset Returns: A New Approach.” Econometrica, 59 (1991), 347–370.CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.CrossRefGoogle Scholar
Sharpe, W. F. “Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk.” Journal of Finance, 19 (1964), 425–442.Google Scholar
Spiegel, M., and Wang, X.. “Cross-Sectional Variation in Stock Returns: Liquidity and Idiosyncratic Risk.” Working Paper No. 05–13, Yale ICF (2005).Google Scholar
Tinic, S. M., and West, R. R.. “Risk, Return and Equilibrium: A Revisit.” Journal of Political Economy, 94 (1986), 126–147.CrossRefGoogle Scholar
Xu, Y., and Malkiel, B. G.. “Investigating the Behavior of Idiosyncratic Volatility.” Journal of Business, 76 (2003), 613–644.CrossRefGoogle Scholar