Time horizon trading and the idiosyncratic risk puzzle

Juliana Malagon, David Moreno and Rosa Rodr�guez

Quantitative Finance, 2015, vol. 15, issue 2, 327-343

Abstract: We analyse whether the idiosyncratic risk puzzle reported by Ang et al . can be explained by the existence of market participants with different investment horizons. We adopt a wavelet multiresolution analysis to decompose the returns distribution for different time scales. Our approach divides the nonlinear link between expected returns and idiosyncratic risk into two linear relationships, a positive one for long-run investors and a negative one for short-run investors, indicating that the puzzle disappears as the wavelet scale increases (long-term horizons). Our results are robust to several types of wavelets, to different definitions of short-term investors and to various measures of idiosyncratic risk.

Date: 2015
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DOI: 10.1080/14697688.2012.755560

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