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The Information Content of Idiosyncratic Volatility

Published online by Cambridge University Press:  01 February 2009

George J. Jiang ,
Danielle Xu  and
Tong Yao
George J. Jiang
Affiliation:
Eller College of Management, University of Arizona, PO Box 210108, Tucson, AZ 85721. [email protected]
Danielle Xu
Affiliation:
School of Business Administration, Gonzaga University, 502 E. Boone Ave., Spokane, WA 99258. [email protected]
Tong Yao
Affiliation:
Tippie College of Business, University of Iowa, 108 John Pappajohn Business Bldg., Iowa City, IA 52242. [email protected]
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Abstract

Ang, Hodrick, Xing, and Zhang (2006a) show that stocks with high idiosyncratic return volatility tend to have low future returns. This paper further documents that idiosyncratic volatility is inversely related to future earning shocks, and more importantly, that the return-predictive power of idiosyncratic volatility is induced by its information content about future earnings. We examine various explanations of the triangular relation among idiosyncratic volatility, future earning shocks, and future stock returns. Our results show that the idiosyncratic volatility anomaly is not a simple manifestation of previously documented market anomalies related to excessive extrapolation on firm growth, over-investment tendency, accounting accruals, or investor underreaction to earnings news. On the other hand, there is evidence that the idiosyncratic volatility anomaly is related to corporate selective disclosure, and the anomaly is stronger among stocks with a less sophisticated investor base.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 44 , Issue 1 , February 2009 , pp. 1 - 28
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2009

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