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Idiosyncratic Volatility and Product Market Competition

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  • Gaspar, José-Miguel
  • Massa, Massimo
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    Abstract

    This Paper investigates the link between a firm’s competitive environment and the idiosyncratic volatility of its stock returns. We find that firms enjoying high market power, or established in concentrated industries, have lower idiosyncratic volatility. We posit that competition affects volatility in two distinct and inter-related ways. Market power works as a hedging instrument that smoothes out idiosyncratic fluctuations. At the same time, a high degree of market power implies lower information uncertainty for investors and therefore lower return volatility. We find strong support for both effects. Our results contribute to the understanding of recent trends of idiosyncratic volatility, and confirm the important link between stock market performance and the competitive environment of firms.

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    Bibliographic Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4812.

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    Date of creation: Dec 2004
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    Handle: RePEc:cpr:ceprdp:4812

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    Related research

    Keywords: competition; idiosyncratic volatility; market powers; uncertainty;

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    Cited by:
    1. Hyunbae Chun & Jung-Wook Kim & Randall Morck & Bernard Yeung, 2007. "Creative Destruction and Firm-Specific Performance Heterogeneity," NBER Working Papers 13011, National Bureau of Economic Research, Inc.
    2. J. Christina Wang, 2006. "Financial innovations, idiosyncratic risk, and the joint evolution of real and financial volatilities," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.

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