Good idiosyncratic volatility, bad idiosyncratic volatility, and the cross-section of stock returns

Yunting Liu and Yandi Zhu

Journal of Banking & Finance, 2025, vol. 170, issue C

Abstract: We decompose the idiosyncratic volatility of stock returns into “good” and “bad” volatility components, which are associated with positive and negative returns, respectively. Using firm characteristics, we estimate a cross-sectional model for the expected idiosyncratic good minus bad volatility (EIGMB). The EIGMB outperforms expected idiosyncratic skewness (EISKEW) and standard time-series models in capturing conditional idiosyncratic return asymmetry. EIGMB is negatively and significantly associated with future stock returns, even after controlling for EIKSEW and exposure to systematic-skewness-related factors. Separating the role each specific characteristic plays in driving the predictive power of EIGMB for returns, we find that return on equity and momentum are two important elements of variation in EIGMB.

Keywords: Idiosyncratic skewness; Good volatility; Bad volatility; Cross-sectional stock returns; Risk factors; Growth options (search for similar items in EconPapers)
JEL-codes: G10 G12 G13 G17 G31 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:170:y:2025:i:c:s0378426624002577

DOI: 10.1016/j.jbankfin.2024.107343

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