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Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle
Author(s) -
STAMBAUGH ROBERT F.,
YU JIANFENG,
YUAN YU
Publication year - 2015
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12286
Subject(s) - arbitrage , volatility (finance) , economics , equity (law) , limits to arbitrage , financial economics , econometrics , asymmetry , relation (database) , monetary economics , physics , quantum mechanics , computer science , law , database , political science
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.