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Incomplete information, idiosyncratic volatility and stock returns

  • Tony BERRADA

    (University of Geneva and Swiss Finance Institute)

  • Julien HUGONNIER

    (University of Lausanne and Swiss Finance Institute)

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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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
Contact details of provider: Web page: http://www.SwissFinanceInstitute.ch

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