Idiosyncratic Return Volatility, Cash Flows, and Product Market Competition

Paul J. Irvine and Jeffrey Pontiff

The Review of Financial Studies, 2009, vol. 22, issue 3, 1149-1177

Abstract: Over the past 40 years, the volatility of the average stock return has drastically outpaced total market volatility. Thus, idiosyncratic return volatility has dramatically increased. We estimate this increase to be 6% per year. Consistent with an efficient market, this result is mirrored by an increase in the idiosyncratic volatility of fundamental cash flows. We argue that these findings are attributable to the more intense economy-wide competition. Various cross-sectional and time-series tests support this idea. Economic competitiveness facilitates reinterpretation of the results from the cross-country R2 literature, as well as the US idiosyncratic risk literature.

Date: 2009
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