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Comparing different explanations of the volatility trend

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  • Rubin, Amir
  • Smith, Daniel R.

Abstract

We analyze the puzzling behavior of the volatility of individual stock returns over the past few decades. The literature has provided many different explanations to the trend in volatility and this paper tests the viability of the different explanations. Virtually all current theoretical arguments that are provided for the trend in the average level of volatility over time lend themselves to explanations about the difference in volatility levels between firms in the cross-section. We therefore focus separately on the cross-sectional and time-series explanatory power of the different proxies. We fail to find a proxy that is able to explain both dimensions well. In particular, we find that Cao et al. [Cao, C., Simin, T.T., Zhao, J., 2008. Can growth options explain the trend in idiosyncratic risk? Review of Financial Studies 21, 2599-2633] market-to-book ratio tracks average volatility levels well, but has no cross-sectional explanatory power. On the other hand, the low-price proxy suggested by Brandt et al. [Brandt, M.W., Brav, A., Graham, J.R., Kumar, A., 2010. The idiosyncratic volatility puzzle: time trend or speculative episodes. Review of Financial Studies 23, 863-899] has much cross-sectional explanatory power, but has virtually no time-series explanatory power. We also find that the different proxies do not explain the trend in volatility in the period prior to 1995 (R-squared of virtually zero), but explain rather well the trend in volatility at the turn of the Millennium (1995-2005).

Suggested Citation

  • Rubin, Amir & Smith, Daniel R., 2011. "Comparing different explanations of the volatility trend," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1581-1597, June.
  • Handle: RePEc:eee:jbfina:v:35:y:2011:i:6:p:1581-1597
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    Cited by:

    1. Faisal Khan & Saif-Ur-Rehman Khan & Hashim Khan, 2016. "Pricing of Risk, Various Volatility Dynamics and Macroeconomic Exposure of Firm Returns: New Evidence on Age Effect," International Journal of Economics and Financial Issues, Econjournals, vol. 6(2), pages 551-561.
    2. repec:bla:irvfin:v:17:y:2017:i:3:p:395-425 is not listed on IDEAS
    3. Peterson, David R. & Smedema, Adam R., 2011. "The return impact of realized and expected idiosyncratic volatility," Journal of Banking & Finance, Elsevier, vol. 35(10), pages 2547-2558, October.
    4. Mehmet Umutlu & Levent Akdeniz & Aslihan Altay-Salih, 2013. "Foreign Equity Trading and Average Stock-return Volatility," The World Economy, Wiley Blackwell, vol. 36(9), pages 1209-1228, September.
    5. Vozlyublennaia, Nadia, 2013. "Do firm characteristics matter for the dynamics of idiosyncratic risk?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 27(C), pages 35-46.

    More about this item

    Keywords

    Volatility Trend Turnover;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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