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Pricing Implications of Noise

Author

Listed:
  • Christian L Goulding
  • Shrihari Santosh
  • Xingtan Zhang

Abstract

We study the interaction between noisy demand and skewed asset payoffs. In our model, price as a function of quantities is convex in a neighborhood around zero if and only if skewness is positive. The combination of convexity and noise produces the idiosyncratic skewness effect, a documented negative relationship between an asset’s idiosyncratic skewness and its expected return. We further offer an explanation for the idiosyncratic volatility puzzle. Finally, our theory predicts that higher idiosyncratic skewness strengthens the idiosyncratic volatility effect (and vice versa). We find support for this prediction in the cross-section of stock returns.

Suggested Citation

  • Christian L Goulding & Shrihari Santosh & Xingtan Zhang, 2023. "Pricing Implications of Noise," The Review of Financial Studies, Society for Financial Studies, vol. 36(6), pages 2468-2508.
    • Handle: RePEc:oup:rfinst:v:36:y:2023:i:6:p:2468-2508.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhac082
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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