Have We Solved the Idiosyncratic Volatility Puzzle?

Kewei Hou and Roger Loh
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Kewei Hou: OH State University
Roger Loh: Singapore Management University

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: We propose a simple methodology to evaluate a large number of potential explanations for the negative relation between idiosyncratic volatility and subsequent stock returns (the idiosyncratic volatility puzzle). We find that surprisingly many existing explanations explain less than 10% of the puzzle. On the other hand, explanations based on investors' lottery preferences, short-term return reversal, and earnings shocks show greater promise in explaining the puzzle. Together they account for 60-80% of the negative idiosyncratic volatility-return relation. Our methodology can be applied to evaluate competing explanations for a broad range of topics in asset pricing and corporate finance.

JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2012-12
New Economics Papers: this item is included in nep-fmk and nep-sea
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2012-28

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