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Technical trading index, return predictability and idiosyncratic volatility

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  • Ma, Yao
  • Yang, Baochen
  • Su, Yunpeng

Abstract

This study examines the cross-sectional return predictability of technical trading index and tests whether the source and the persistence of technical trading effect is the result of idiosyncratic volatility limiting arbitrage in the Chinese stock market. By eliminating common noise components in technical indicators, we propose a new technical trading index, TECHIWC, which negatively predicts future returns from short to long terms. This predictive power is not subsumed by other well-known firm characteristics. Furthermore, we find that the relationship between the TECHIWC effect and idiosyncratic volatility is significantly positive, which is consistent with idiosyncratic volatility limiting arbitrage of the TECHIWC effect. Finally, this relationship is robust to consideration of other limits of arbitrage, market states, and alternative specifications of idiosyncratic volatility.

Suggested Citation

  • Ma, Yao & Yang, Baochen & Su, Yunpeng, 2020. "Technical trading index, return predictability and idiosyncratic volatility," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 879-900.
    • Handle: RePEc:eee:reveco:v:69:y:2020:i:c:p:879-900
    DOI: 10.1016/j.iref.2020.07.006
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    Cited by:

    1. Ma, Yao & Yang, Baochen & Li, Jinyong & Shen, Yue, 2023. "Trend information and cross-sectional returns: The role of analysts," Pacific-Basin Finance Journal, Elsevier, vol. 80(C).
    2. Yang, Baochen & Ye, Tao & Ma, Yao, 2022. "Financing anomaly, mispricing and cross-sectional return predictability," International Review of Economics & Finance, Elsevier, vol. 79(C), pages 579-598.
    3. Ma, Yao & Yang, Baochen & Su, Yunpeng, 2021. "Stock return predictability: Evidence from moving averages of trading volume," Pacific-Basin Finance Journal, Elsevier, vol. 65(C).

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    More about this item

    Keywords

    Technical trading index; Contrarian; Idiosyncratic volatility; Iterated combination approach; Return predictability;
    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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