On the conditional performance of the IVOL anomaly

Jianqiu Wang, Ke Wu and Jiening Pan

International Review of Economics & Finance, 2024, vol. 89, issue PA, 337-350

Abstract: This paper proposes that the well-known idiosyncratic volatility (IVOL) puzzle is partly due to an overconditioning bias in IVOL estimates when there exists nonlinearity between stock and factor returns. We analytically derive the overconditioning bias when beta and IVOL are contemporaneously estimated using daily returns. To mitigate the estimation bias, we employ a conditional factor model, as in Avramov and Chordia (2006), to estimate systematic risk exposure and IVOL. Our empirical results show that the conditional IVOL estimates do not imply a negative return premium when firm fundamentals are used as conditioning variables, and the associated conditional factor-adjusted alpha is much smaller than the original IVOL puzzle. Our findings are robust in the U.S. and Chinese stock markets.

Keywords: Idiosyncratic volatility; Conditional factor models; Overconditioning bias; Firm characteristics (search for similar items in EconPapers)
JEL-codes: C13 G12 G14 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:89:y:2024:i:pa:p:337-350

DOI: 10.1016/j.iref.2023.07.032

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