The dual effect of idiosyncratic volatility on stock pricing and return
This study aims to examine what underlies the estimated relation between idiosyncratic volatility and realized return. Idiosyncratic volatility has a dual effect on stock pricing: it not only affects investors' expected return but also affects the efficiency of stock price in reflecting its...
| Main Authors: | , |
|---|---|
| Format: | Article |
| Language: | English |
| Published: |
Emerald Publishing
2022-06-01
|
| Series: | China Accounting and Finance Review |
| Subjects: | |
| Online Access: | https://www.emerald.com/insight/content/doi/10.1108/CAFR-02-2022-0009/full/html |
| _version_ | 1797687021156696064 |
|---|---|
| author | Zhuo (June) Cheng Jing (Bob) Fang |
| author_facet | Zhuo (June) Cheng Jing (Bob) Fang |
| author_sort | Zhuo (June) Cheng |
| collection | DOAJ |
| description | This study aims to examine what underlies the estimated relation between idiosyncratic volatility and realized return.
Idiosyncratic volatility has a dual effect on stock pricing: it not only affects investors' expected return but also affects the efficiency of stock price in reflecting its value. Therefore, the estimated relation between idiosyncratic volatility and realized return captures its relations with both expected return and the mispricing-related component due to its dual effect on stock pricing. The sign of its relation with the mispricing-related component is indeterminate.
The estimated relation between idiosyncratic volatility and realized return decreases and switches from positive to negative as the estimation sample consists of proportionately more ex ante overvalued observations; it increases and switches from negative to positive as the estimation sample consists of proportionately more ex post overvalued observations. In sum, the relation of idiosyncratic volatility with the mispricing-related component dominates its relation with expected return in its estimated relation with realized return. Moreover, its estimated relation with realized return varies with research design choices and even switches sign due to their effects on its relation with the mispricing-related component.
The novelty of the study is evident in the implication of its findings that one cannot infer the sign of the relation of idiosyncratic volatility with expected return from its estimated relation with realized return. |
| first_indexed | 2024-03-12T01:12:19Z |
| format | Article |
| id | doaj.art-f436747928c14ab18f349c136d57abe2 |
| institution | Directory Open Access Journal |
| issn | 2307-3055 |
| language | English |
| last_indexed | 2024-03-12T01:12:19Z |
| publishDate | 2022-06-01 |
| publisher | Emerald Publishing |
| record_format | Article |
| series | China Accounting and Finance Review |
| spelling | doaj.art-f436747928c14ab18f349c136d57abe22023-09-14T02:57:14ZengEmerald PublishingChina Accounting and Finance Review2307-30552022-06-0124222625910.1108/CAFR-02-2022-0009The dual effect of idiosyncratic volatility on stock pricing and returnZhuo (June) Cheng0https://orcid.org/0000-0001-7521-2938Jing (Bob) Fang1https://orcid.org/0000-0003-1522-9513The Hong Kong Polytechnic UniversityThe Hong Kong Polytechnic UniversityThis study aims to examine what underlies the estimated relation between idiosyncratic volatility and realized return. Idiosyncratic volatility has a dual effect on stock pricing: it not only affects investors' expected return but also affects the efficiency of stock price in reflecting its value. Therefore, the estimated relation between idiosyncratic volatility and realized return captures its relations with both expected return and the mispricing-related component due to its dual effect on stock pricing. The sign of its relation with the mispricing-related component is indeterminate. The estimated relation between idiosyncratic volatility and realized return decreases and switches from positive to negative as the estimation sample consists of proportionately more ex ante overvalued observations; it increases and switches from negative to positive as the estimation sample consists of proportionately more ex post overvalued observations. In sum, the relation of idiosyncratic volatility with the mispricing-related component dominates its relation with expected return in its estimated relation with realized return. Moreover, its estimated relation with realized return varies with research design choices and even switches sign due to their effects on its relation with the mispricing-related component. The novelty of the study is evident in the implication of its findings that one cannot infer the sign of the relation of idiosyncratic volatility with expected return from its estimated relation with realized return.https://www.emerald.com/insight/content/doi/10.1108/CAFR-02-2022-0009/full/htmlidiosyncratic volatilitystock pricing efficiencyrealized returnexpected returnasset pricing puzzle |
| spellingShingle | Zhuo (June) Cheng Jing (Bob) Fang The dual effect of idiosyncratic volatility on stock pricing and return China Accounting and Finance Review idiosyncratic volatility stock pricing efficiency realized return expected return asset pricing puzzle |
| title | The dual effect of idiosyncratic volatility on stock pricing and return |
| title_full | The dual effect of idiosyncratic volatility on stock pricing and return |
| title_fullStr | The dual effect of idiosyncratic volatility on stock pricing and return |
| title_full_unstemmed | The dual effect of idiosyncratic volatility on stock pricing and return |
| title_short | The dual effect of idiosyncratic volatility on stock pricing and return |
| title_sort | dual effect of idiosyncratic volatility on stock pricing and return |
| topic | idiosyncratic volatility stock pricing efficiency realized return expected return asset pricing puzzle |
| url | https://www.emerald.com/insight/content/doi/10.1108/CAFR-02-2022-0009/full/html |
| work_keys_str_mv | AT zhuojunecheng thedualeffectofidiosyncraticvolatilityonstockpricingandreturn AT jingbobfang thedualeffectofidiosyncraticvolatilityonstockpricingandreturn AT zhuojunecheng dualeffectofidiosyncraticvolatilityonstockpricingandreturn AT jingbobfang dualeffectofidiosyncraticvolatilityonstockpricingandreturn |