Separating Up from Down: New Evidence on the Idiosyncratic Volatility - Return Relation

43 Pages Posted: 20 Mar 2007 Last revised: 21 Feb 2013

See all articles by Laura Frieder

Laura Frieder

Purdue University - Krannert School of Management

George J. Jiang

Washington State University

Date Written: July 1, 2007


The finding that stocks with high idiosyncratic volatility tend to have low future returns has been dubbed an empirical anomaly in the finance literature. We seek to understand this puzzle by separating the upside volatility associated with positive idiosyncratic returns from the downside risk associated with negative idiosyncratic returns. We find that downside risk is not inversely related to future stock returns, thus easing the concern that the empirical anomaly is a mispricing of risk. Rather, our results suggest that it is upside volatility that drives the inverse idiosyncratic volatility and return relation. We further examine whether the relation of future returns with downside and upside volatility accords with investor underreaction to bad news and overreaction to good news. Finally, we show that momentum strategies may be enhanced by taking into account stocks' upside volatility.

Keywords: idiosyncratic volatility, risk

JEL Classification: G12

Suggested Citation

Frieder, Laura and Jiang, George, Separating Up from Down: New Evidence on the Idiosyncratic Volatility - Return Relation (July 1, 2007). AFA 2008 New Orleans Meetings Paper, Available at SSRN: or

Laura Frieder (Contact Author)

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

George Jiang

Washington State University ( email )

Department of Finance and Management Science
Carson College of Business
Pullman, WA 99-4746164
United States
509-3354474 (Phone)


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