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Exploring the Nonlinear Idiosyncratic Volatility Puzzle: Evidence from China

Author

Listed:
  • B. Li
  • S. Boubaker

    (Métis Lab EM Normandie - EM Normandie - École de Management de Normandie = EM Normandie Business School)

  • Z. Liu
  • W. Louhichi
  • Y. Yao

Abstract

This paper studies the spectrum of the idiosyncratic volatility (IVOL) puzzle in the Chinese A-share market using functional data analysis (FDA). It highlights a nonlinear IVOL puzzle with a steady reduction in the bottom 20% of average returns and a large drop of 1% in the top 10%, consistent with the herding, certainty, and reflection effects in China's A-share markets. Furthermore, empirical evidence suggests that the FDA technique has a 30% greater goodness of fit than linear regressions, suggesting that nonlinearity plays a non-negligible role in the IVOL puzzle. These results can be useful for investors and hedgers, as they show that stock returns decline accelerated as the IVOL increases. \textcopyright 2022, The Author(s), under exclusive licence to Springer Science+Business Media, LLC, part of Springer Nature.

Suggested Citation

  • B. Li & S. Boubaker & Z. Liu & W. Louhichi & Y. Yao, 2023. "Exploring the Nonlinear Idiosyncratic Volatility Puzzle: Evidence from China," Post-Print hal-04435519, HAL.
    • Handle: RePEc:hal:journl:hal-04435519
    DOI: 10.1007/s10614-022-10265-3
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    JEL classification:

    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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