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Idiosyncratic volatility, returns, and mispricing: No real anomaly in sight

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  • Zaremba, Adam
  • Czapkiewicz, Anna
  • Będowska-Sójka, Barbara

Abstract

Recent empirical evidence has shown that the relationship between idiosyncratic volatility and a stock's expected return depends on the pricing of the stock: it is negative among overvalued stocks and positive among undervalued ones. We provide both theoretical and numerical evidence that this risk-return relationship might be driven purely by mathematical properties of return distributions. Using a simulation-based approach, we document that even in completely random samples, the correlation between idiosyncratic risk and mean returns depends on the ex-post estimation of abnormal returns.

Suggested Citation

  • Zaremba, Adam & Czapkiewicz, Anna & Będowska-Sójka, Barbara, 2018. "Idiosyncratic volatility, returns, and mispricing: No real anomaly in sight," Finance Research Letters, Elsevier, vol. 24(C), pages 163-167.
    • Handle: RePEc:eee:finlet:v:24:y:2018:i:c:p:163-167
    DOI: 10.1016/j.frl.2017.09.002
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    References listed on IDEAS

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    Cited by:

    1. Fenner, Richard G. & Han, Yufeng & Huang, Zhaodan, 2020. "Idiosyncratic volatility shocks, behavior bias, and cross-sectional stock returns," The Quarterly Review of Economics and Finance, Elsevier, vol. 75(C), pages 276-293.
    2. Li, Xing & Hou, Keqiang & Zhang, Chao, 2020. "Intangible factor and idiosyncratic volatility puzzles," Finance Research Letters, Elsevier, vol. 34(C).

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    More about this item

    Keywords

    Idiosyncratic volatility; Low-risk anomaly; Abnormal returns; Return predictability; Mispricing; Stock market anomalies; Monte Carlo simulation;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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