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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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    2. Aman, Hiroyuki & Moriyasu, Hiroshi, 2017. "Volatility and public information flows: Evidence from disclosure and media coverage in the Japanese stock market," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 660-676.
    3. Ma, Chaoqun & Wang, Hailong & Cheng, Fengchao & Hu, Duni, 2017. "Asset pricing and institutional investors with disagreements," Economic Modelling, Elsevier, vol. 64(C), pages 231-248.
    4. 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.
    5. Diogo Silva & António Cerqueira, 2021. "Financial Reporting Quality and Investors' Divergence of Opinion†," Accounting Perspectives, John Wiley & Sons, vol. 20(1), pages 79-107, March.
    6. Ons Triki & Fathi Abid, 2025. "Corporate full-scale hedging and pricing of high-risk growth investment option," Review of Derivatives Research, Springer, vol. 28(3), pages 1-42, October.
    7. Harjoat S. Bhamra & Raman Uppal, 2014. "Asset Prices with Heterogeneity in Preferences and Beliefs," The Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 519-580.
    8. Jungshik Hur & Cedric Mbanga Luma, 2017. "Aggregate idiosyncratic volatility, dynamic aspects of loss aversion, and narrow framing," Review of Quantitative Finance and Accounting, Springer, vol. 49(2), pages 407-433, August.
    9. He, Feng & Liu, Guanchun & Hao, Jing & Li, Youwei, 2023. "CSR performance and firm idiosyncratic risk in a data-rich environment: The role of retail investor attention," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 89(C).
    10. Xiang Zhang & Han Zhou, 2020. "Leverage structure and stock price synchronicity: Evidence from China," PLOS ONE, Public Library of Science, vol. 15(7), pages 1-15, July.
    11. Yi-Shu Wang & Ting-Chen & Zhen-Jia-Liu, 2020. "The Relationship between Accounting Information Quality and Idiosyncratic Volatility: An Empirical Study on Chinese A-Share Listed Companies," Eurasian Journal of Business and Management, Eurasian Publications, vol. 8(2), pages 150-166.

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    Keywords

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    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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