Fundamental Uncertainties and Firm-level Stock Volatilities

Firm-level stock volatility has increased significantly since 1962 and varies widely across industries. Recent literature shows that the excessive and persistent stock volatility can be well explained by fundamental uncertainties. This paper conducted panel data analyses on 415 firms during 1988-2001 in an effort to study the extent to which variation of individual stock returns can be explained by fundamental uncertainties. Mainly, we examined the uncertainty effects of demand shifts and a firm’s innovative activities as well as other firm and industry characteristic variables on firm level idiosyncratic stock volatility. The results from the panel data analyses suggest that R&D intensive firms or firms in high-tech industries have more volatile returns. Idiosyncratic volatility is higher when there is greater demand uncertainty. Data also support the prediction that idiosyncratic volatility is higher for small firms and a firm with higher volatility of profitability. In addition, we find some evidence that idiosyncratic volatility increases with variation in analysts’ earnings forecasts used as a proxy for changes in expectations that are associated with uncertainty and heterogeneous belief. Trading volume, which is used as a control variable for the information arrival, is found to endogenously increase idiosyncratic volatility. Furthermore, a firm’s leverage is observed to have a significant and positive effect on idiosyncratic volatility in our whole panel data sample as well as the down market sample. However, we also observed a reverse leverage effect in the upward market sample. Finally, various empirical tests suggest that the idiosyncratic volatilities are persistent.