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Incomplete information, idiosyncratic volatility and stock returns

Author

Listed:
  • Tony BERRADA

    (University of Geneva and Swiss Finance Institute)

  • Julien HUGONNIER

    (University of Lausanne and Swiss Finance Institute)

Abstract

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.

Suggested Citation

  • Tony BERRADA & Julien HUGONNIER, 2008. "Incomplete information, idiosyncratic volatility and stock returns," Swiss Finance Institute Research Paper Series 08-23, Swiss Finance Institute.
  • Handle: RePEc:chf:rpseri:rp0823
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    References listed on IDEAS

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    1. repec:eee:reveco:v:51:y:2017:i:c:p:660-676 is not listed on IDEAS
    2. Harjoat S. Bhamra & Raman Uppal, 2014. "Asset Prices with Heterogeneity in Preferences and Beliefs," Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 519-580.
    3. repec:kap:rqfnac:v:49:y:2017:i:2:d:10.1007_s11156-016-0595-8 is not listed on IDEAS
    4. repec:eee:ecmode:v:64:y:2017:i:c:p:231-248 is not listed on IDEAS
    5. Gider, Jasmin & Westheide, Christian, 2016. "Relative idiosyncratic volatility and the timing of corporate insider trading," Journal of Corporate Finance, Elsevier, vol. 39(C), pages 312-334.

    More about this item

    Keywords

    Idiosyncratic volatility; incomplete information; cross-section of returns; q-theory of investment;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing

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