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Liquidity Biases and the Pricing of Cross-Sectional Idiosyncratic Volatility around the World

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  • Han, Yufeng
  • Hu, Ting
  • Lesmond, David A.

Abstract

This paper examines data from 45 world markets and shows that the previously documented relation between mean returns and idiosyncratic volatility arises because of biases in volatility estimates that we can attribute to the bid–ask bounce in trade prices. We show that no significant relation exists between mean returns and idiosyncratic volatility estimated from quote-midpoint returns. Further, there is no significant relation between mean returns and the portion of transaction-price-based idiosyncratic volatility that is orthogonal to bid–ask spreads. The pricing of idiosyncratic volatility is due to the negative pricing of the bid–ask spread.

Suggested Citation

  • Han, Yufeng & Hu, Ting & Lesmond, David A., 2015. "Liquidity Biases and the Pricing of Cross-Sectional Idiosyncratic Volatility around the World," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 50(6), pages 1269-1292, December.
    • Handle: RePEc:cup:jfinqa:v:50:y:2015:i:06:p:1269-1292_00
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    Cited by:

    1. Bin Liu & Monica Tan & Marie-Anne Cam, 2019. "Reinvestigate the Bid–Ask Bounce Effect and Pricing of Idiosyncratic Volatility: The Case of the Australian Market," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 22(01), pages 1-23, March.
    2. Han, Yufeng & Hu, Ou & Huang, Zhaodan, 2023. "A tale of idiosyncratic volatility and illiquidity shocks: Their correlation and effects on stock returns," International Review of Financial Analysis, Elsevier, vol. 86(C).
    3. Joshua Traut, 2023. "What we know about the low-risk anomaly: a literature review," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 37(3), pages 297-324, September.
    4. Le, Nhan & Nguyen, Duc Duy & Sila, Vathunyoo, 2021. "Does shareholder litigation affect the corporate information environment?," Journal of Financial Markets, Elsevier, vol. 56(C).
    5. Annaert, Jan & De Ceuster, Marc & Van Doninck, Freek, 2022. "Decomposing the idiosyncratic volatility anomaly among euro area stocks," Finance Research Letters, Elsevier, vol. 47(PB).
    6. Malagon, Juliana & Moreno, David & Rodríguez, Rosa, 2018. "Idiosyncratic volatility, conditional liquidity and stock returns," International Review of Economics & Finance, Elsevier, vol. 53(C), pages 118-132.

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