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IDIOSYNCRATIC RISK PREMIA AND MOMENTUM

Authors


  • We wish to thank the following people for their extremely useful comments: Gregory W. Brown, Jennifer Conrad, Tarun Chordia, Michael Ferguson, Hui Guo, Brian Hatch, Steven L. Jones (associate editor), Yong Kim, David Manzler, Nadia Vozlyublennaia (reviewer), and Diana Wei. Any errors of omission or commission are ours alone.

Abstract

Theory predicts that in the presence of incomplete information, underdiversified investors will demand idiosyncratic risk premia (IRP) as compensation for idiosyncratic volatility (IV). We estimate IV and IRP at the individual stock level and document the extent to which momentum profits can be explained by cross-sectional variation in IRP. We show that a large portion of momentum profits can be explained by cross-sectional variation in IRP and that, as predicted by theory, variations in both momentum profits and IRP are related to the ratio of firm size to investor base. However, significant momentum profits in low-IV securities cannot be explained by cross-sectional variation in IRP.

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