The Common Factor in Idiosyncratic Volatility

Stijn Van Nieuwerburgh, Hanno Lustig, Bryan Kelly and Bernard Herskovic
Additional contact information
Hanno Lustig: Anderson School of Business
Bryan Kelly: University of Chicago
Bernard Herskovic: New York University

No 810, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: We show that firms' idiosyncratic volatility in returns and cash flows obeys a strong factor structure. We find that the stocks of firms with large, negative common idiosyncratic volatility (CIV) factor betas earn high average returns. The CIV beta quintile spread is 6.4% per year. To explain this spread, we develop a heterogeneous investor model with incomplete markets in which the idiosyncratic volatility of investor consumption growth inherits the factor structure of firm cash flow growth. In our model, the CIV factor is a priced state variable, because an increase in volatility represents a worsening of the investment opportunity set for the average investor. The calibrated model is able to match the high degree of comovement in idiosyncratic volatilities, the CIV beta spread, along with a host of asset price moments.

Date: 2014
New Economics Papers: this item is included in nep-dge and nep-mac
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Citations: View citations in EconPapers (20)

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Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:810

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