The Dynamic Relation Between Returns and Idiosyncratic Volatility

Authors

  • Xiaoquan Jiang,

  • Bong-Soo Lee

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    • *Xiaoquan Jiang is an Assistnat Professor of Finaance at the University of Northern Iowa in Cedar Falls, IA. Bong-Soo Lee is a Professor of Fincance at the KAIST Graduate School of Finance, Seoul, Korea and Florida Srtarte University, Tallahassee, FL.


Abstract

We claim that regressing excess returns on one-lagged volatility provides only a limited picture of the dynamic effect of idiosyncratic risk, which tends to be persistent over time. By correcting for the serial correlation in idiosyncratic volatility, we find that idiosyncratic volatility has a significant positive effect. This finding seems robusrt for various firm size portfolios, sample periods, and measures of idiosyncratic risk. Our findings suggest stock markets mis-price idiosyncratic risk. There may be some measurement problems with idiosyncratic risk. There may be some measurement problems with idiosyncratic risk that could be related to nondiversifiable risk.

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