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Incomplete information, idiosyncratic volatility and stock returns

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Author Info
Tony BERRADA (University of Geneva and Swiss Finance Institute)
Julien HUGONNIER (University of Lausanne and Swiss Finance Institute)
Abstract

We develop a q-theoretic model of investment under incomplete information that explains the link between idiosyncratic volatility and stock returns. When calibrated to match properties of the US business cycles as well as various firms and industry characteristics, the model generates a negative relation between idiosyncratic volatility and stock returns. We show that conditional on earning surprises, the link is positive after good news and negative after bad news. This result provides new insights on the nature of stock return predictability.

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Publisher Info
Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-23.

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Length: 49 pages
Date of creation: Jul 2008
Date of revision:
Handle: RePEc:chf:rpseri:rp0823

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Web page: http://www.SwissFinanceInstitute.ch
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Related research
Keywords: Idiosyncratic volatility; incomplete information; cross-section of returns; q-theory of investment;

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing

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This page was last updated on 2009-11-30.

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