Idiosyncratic Volatility, Stock Market Volatility, And Expected Stock Returns

Topics:
Equity
Tags:
Finance,
Investment,
Stock,
Stock Market,
Volatility
Source:
Federal Reserve Bank of St. Louis

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Overview: "Theories suggest that both stock market risk and idiosyncratic risk are important determinants of the equity premium but empirical evidence is inconclusive. This paper shows that the (value-weighted) idiosyncratic stock volatility in conjunction with aggregate stock market volatility exhibits strong predictive abilities for excess stock market returns. Consistent with the CAPM, one finds a positive relation between stock market risk and returns. However, contrary to the conventional wisdom, the idiosyncratic volatility is negatively related to future stock returns in the data. This puzzling result reflects the fact that the idiosyncratic volatility is negatively correlated with the consumption-wealth ratio, which, as argued by some recent authors, is a proxy for the liquidity premium due to non-traded human capital. Keywords: Idiosyncratic Stock Volatility, Stock Market Volatility, Consumption-Wealth Ratio, Stock Return Predictability, Out-of-Sample Forecast, Stock Market Timing Strategies, and Portfolio Choices. "

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Format: PDF | Size: 260KB | Date: Sep 2003 | Pages: 40

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