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Idiosyncratic Volatility and the Cross Section of Expected Returns

Published online by Cambridge University Press:  06 April 2009

Turan G. Bali  and
Nusret Cakici
Turan G. Bali
Affiliation:
[email protected], Department of Economics and Finance, Baruch College, Zicklin School of Business, City University of New York, One Bernard Baruch Way, Box 10-225, New York, NY 10010 and College of Administrative Sciences and Economics, Koc University, Rumeli Feneri Yolu, Istanbul, Turkey 34450
Nusret Cakici
Affiliation:
[email protected], Department of Economics and Finance, School of Global Management, Arizona State University, PO Box 37100, Phoenix, AZ 85069.
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Abstract

This paper examines the cross-sectional relation between idiosyncratic volatility and expected stock returns. The results indicate that i) the data frequency used to estimate idiosyncratic volatility, ii) the weighting scheme used to compute average portfolio returns, iii) the breakpoints utilized to sort stocks into quintile portfolios, and iv) using a screen for size, price, and liquidity play critical roles in determining the existence and significance of a relation between idiosyncratic risk and the cross section of expected returns. Portfoliolevel analyses based on two different measures of idiosyncratic volatility (estimated using daily and monthly data), three weighting schemes (value-weighted, equal-weighted, inverse volatility-weighted), three breakpoints (CRSP, NYSE, equal market share), and two different samples (NYSE/AMEX/NASDAQ and NYSE) indicate that no robustly significant relation exists between idiosyncratic volatility and expected returns.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 43 , Issue 1 , March 2008 , pp. 29 - 58
Copyright
Copyright © School of Business Administration, University of Washington 2008

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