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A Model-Free Measure of Aggregate Idiosyncratic Volatility and the Prediction of Market Returns

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  • René Garcia
  • Daniel Mantilla-Garcia
  • Lionel Martellini

Abstract

In this paper, we formally show that the cross-sectional variance of stock returns is a consistent and asymptotically efficient estimator for aggregate idiosyncratic volatility. This measure has two key advantages: it is model-free and observable at any frequency. Previous approaches have used monthly model based measures constructed from time series of daily returns. The newly proposed cross-sectional volatility measure is a strong predictor for future returns on the aggregate stock market at the daily frequency. Using the cross-section of size and book-to-market portfolios, we show that the portfolios' exposures to the aggregate idiosyncratic volatility risk predict the cross-section of expected returns.

Suggested Citation

  • René Garcia & Daniel Mantilla-Garcia & Lionel Martellini, 2013. "A Model-Free Measure of Aggregate Idiosyncratic Volatility and the Prediction of Market Returns," CIRANO Working Papers 2013s-01, CIRANO.
  • Handle: RePEc:cir:cirwor:2013s-01
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    References listed on IDEAS

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    Cited by:

    1. Maio, Paulo, 2016. "Cross-sectional return dispersion and the equity premium," Journal of Financial Markets, Elsevier, vol. 29(C), pages 87-109.
    2. Angelidis, Timotheos & Sakkas, Athanasios & Tessaromatis, Nikolaos, 2015. "Stock market dispersion, the business cycle and expected factor returns," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 265-279.
    3. Miffre, Joëlle & Brooks, Chris & Li, Xiafei, 2013. "Idiosyncratic volatility and the pricing of poorly-diversified portfolios," International Review of Financial Analysis, Elsevier, vol. 30(C), pages 78-85.
    4. repec:eee:ecmode:v:68:y:2018:i:c:p:318-328 is not listed on IDEAS
    5. repec:eee:ecmode:v:69:y:2018:i:c:p:301-312 is not listed on IDEAS

    More about this item

    Keywords

    Aggregate idiosyncratic volatility; cross-sectional dispersion; prediction of market returns;

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