Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle

Robert F. Stambaugh, Jianfeng Yu, Yu Yuan

Research output: Contribution to journalArticlepeer-review

360 Scopus citations

Abstract

Buying is easier than shorting for many equity investors. Combining this arbitrage asymmetry with the arbitrage risk represented by idiosyncratic volatility (IVOL) explains the negative relation between IVOL and average return. The IVOL-return relation is negative among overpriced stocks but positive among underpriced stocks, with mispricing determined by combining 11 return anomalies. Consistent with arbitrage asymmetry, the negative relation among overpriced stocks is stronger, especially for stocks less easily shorted, so the overall IVOL-return relation is negative. Further supporting our explanation, high investor sentiment weakens the positive relation among underpriced stocks and, especially, strengthens the negative relation among overpriced stocks.

Original languageEnglish (US)
Pages (from-to)1903-1948
Number of pages46
JournalJournal of Finance
Volume70
Issue number5
DOIs
StatePublished - Oct 1 2015

Bibliographical note

Publisher Copyright:
© 2015 the American Finance Association.

Fingerprint

Dive into the research topics of 'Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle'. Together they form a unique fingerprint.

Cite this