A Model-Free Measure of Aggregate Idiosyncratic Volatility and the Prediction of Market Returns

58 Pages Posted: 19 Jan 2013

See all articles by René Garcia

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques; University of Montreal

Daniel Mantilla-Garcia

Universidad de Los Andes - School of Management; EDHEC Risk Institute

Lionel Martellini

EDHEC Business School

Date Written: January 18, 2013

Abstract

In this paper, we formally show that the cross-sectional variance of stock returns is a consistent and asymptotically efficient estimator for aggregate idiosyncratic volatility. This measure has two key advantages: it is model-free and observable at any frequency. Previous approaches have used monthly model based measures constructed from time series of daily returns. The newly proposed cross-sectional volatility measure is a strong predictor for future returns on the aggregate stock market at the daily frequency. Using the cross-section of size and book-to-market portfolios, we show that the portfolios’ exposures to the aggregate idiosyncratic volatility risk predict the cross-section of expected returns.

Keywords: Aggregate idiosyncratic volatility, cross-sectional dispersion, prediction of market returns

Suggested Citation

Garcia, René and Mantilla-Garcia, Daniel and Martellini, Lionel, A Model-Free Measure of Aggregate Idiosyncratic Volatility and the Prediction of Market Returns (January 18, 2013). CIRANO - Scientific Publication No. 2013s-01, Available at SSRN: https://ssrn.com/abstract=2202961 or http://dx.doi.org/10.2139/ssrn.2202961

René Garcia (Contact Author)

Université de Montréal - CIREQ - Département de sciences économiques ( email )

C.P. 6128, succursale Centre-Ville
3150, rue Jean-Brillant, bureau C-6027
Montreal, Quebec H3C 3J7
Canada
514-985-4014 (Phone)

University of Montreal ( email )

United States

Daniel Mantilla-Garcia

Universidad de Los Andes - School of Management ( email )

Bogota, Bogota D.C.
Colombia

EDHEC Risk Institute ( email )

Lille
France

Lionel Martellini

EDHEC Business School ( email )

58 rue du Port
Lille, 59046
France

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
421
Abstract Views
1,540
rank
85,554
PlumX Metrics