The Common Factor in Idiosyncratic Volatility: Quantitative Asset Pricing Implications

Bernard Herskovic, Bryan T. Kelly, Hanno Lustig and Stijn Van Nieuwerburgh

No 20076, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We show that firms’ idiosyncratic volatility obeys a strong factor structure and that shocks to the common factor in idiosyncratic volatility (CIV) are priced. Stocks in the lowest CIV-beta quintile earn average returns 5.4% per year higher than those in the highest quintile. The CIV factor helps to explain a number of asset pricing anomalies. We provide new evidence linking the CIV factor to income risk faced by households. These three facts are consistent with an incomplete markets heterogeneous-agent model. In the model, CIV is a priced state variable because an increase in idiosyncratic firm volatility raises the average household’s marginal utility. The calibrated model matches the high degree of comovement in idiosyncratic volatilities, the CIV-beta return spread, and several other asset price moments.

JEL-codes: E44 G12 (search for similar items in EconPapers)
Date: 2014-04
New Economics Papers: this item is included in nep-fmk and nep-mac
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (17)

Published as Herskovic, Bernard & Kelly, Bryan & Lustig, Hanno & Van Nieuwerburgh, Stijn, 2016. "The common factor in idiosyncratic volatility: Quantitative asset pricing implications," Journal of Financial Economics, Elsevier, vol. 119(2), pages 249-283.

Downloads: (external link)
http://www.nber.org/papers/w20076.pdf (application/pdf)

Related works:
Journal Article: The common factor in idiosyncratic volatility: Quantitative asset pricing implications (2016)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:20076

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w20076

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().