Idiosyncratic Volatility, Stock Market Volatility, and Expected Stock Returns

56 Pages Posted: 8 Mar 2004

See all articles by Hui Guo

Hui Guo

University of Cincinnati - Department of Finance - Real Estate

Robert Savickas

George Washington University - School of Business - Department of Finance

Date Written: February 2004

Abstract

We show that the value-weighted idiosyncratic stock volatility and aggregate stock market volatility jointly exhibit strong predictive abilities for excess stock market returns, although they don't do so individually. While we uncover a positive risk-return relation in the stock market, as stipulated by the CAPM, the idiosyncratic volatility is negatively related to future stock returns. One potential explanation for the latter result is that the idiosyncratic volatility is a measure of divergence of opinion, which, as argued by Miller (1977), could lead a stock to be overvalued initially and to suffer capital losses subsequently. However, we find that the idiosyncratic volatility forecasts stock returns mainly because of its negative co-movements with the consumption-wealth ratio, which, as argued by some recent authors, is a proxy for the liquidity premium.

Keywords: Idiosyncratic stock volatility, stock market volatility, consumption-wealth ratio,stock return predictability, out-of-sample forecast, stock market timing strategies, and portfolio choices

JEL Classification: G1

Suggested Citation

Guo, Hui and Savickas, Robert, Idiosyncratic Volatility, Stock Market Volatility, and Expected Stock Returns (February 2004). Available at SSRN: https://ssrn.com/abstract=515143 or http://dx.doi.org/10.2139/ssrn.515143

Hui Guo (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business
418 Carl H. Lindner Hall
Cincinnati, OH 45221
United States
513.556.7077 (Phone)
513.556.0979 (Fax)

HOME PAGE: http://homepages.uc.edu/~guohu/

Robert Savickas

George Washington University - School of Business - Department of Finance ( email )

Funger Hall, Suite 501R
2201 G Street, N.W.
Washington, DC 20052
United States
202-994-8936 (Phone)
202-994-5014 (Fax)

HOME PAGE: http://savickas.net/

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