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Estimating Idiosyncratic Volatility and Its Effects on a Cross-Section of Returns

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  • Serguey Khovansky
  • Zhylyevskyy, Oleksandr

Abstract

We apply a new econometric method -- the generalized method of moments under a common shock -- to estimate idiosyncratic volatility premium and average idiosyncratic stock volatility. In contrast to the popular two-pass estimation approach of Fama and MacBeth (1973), the method requires using only a cross-section of return observations. We apply it to cross-sections of weekly U.S. stock returns in January and October 2008 and fiÂ…nd that during these months, the idiosyncratic volatility premium is nearly always negative and statistically signiÂ…cant. The results also indicate that the average idiosyncratic stock volatility increased by at least 50% between January and October.

Suggested Citation

  • Serguey Khovansky & Zhylyevskyy, Oleksandr, 2012. "Estimating Idiosyncratic Volatility and Its Effects on a Cross-Section of Returns," Staff General Research Papers Archive 34990, Iowa State University, Department of Economics.
  • Handle: RePEc:isu:genres:34990
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    File URL: http://www2.econ.iastate.edu/papers/p14990-2012-01-31.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Generalized method of moments; Idiosyncratic volatility; Cross-section of stock returns; Idiosyncratic volatility premium;

    JEL classification:

    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect 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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