A closer look at the relationship between firm-specific return variation and stock returns
Journal of Accounting Literature
ISSN: 0737-4607
Article publication date: 17 July 2023
Issue publication date: 19 March 2024
Abstract
Purpose
Prior studies use two measures of firm-specific return variation (FSRV): idiosyncratic volatility in absolute and relative terms, the latter of which is also termed stock price nonsynchronicity. Whereas most research focuses on investigating the idiosyncratic volatility puzzle, the authors carry out comparison of these two measures and further investigate which of the two constituents of nonsynchronicity explain the association between FSRV and stock returns, emphasising the importance of assessing which component drives stock returns.
Design/methodology/approach
The authors use the US individual stock returns from 1925 to 2016 and define the two measures of FRSV based on the Fama and French (1993) model. Specifically, the authors decompose the relative measure into two components: (i) absolute idiosyncratic volatility and (ii) systematic volatility. The authors conduct various tests based on high-minus-low, zero-investment quintile portfolio sorts and perform the Fama–MacBeth analysis by singling out each component.
Findings
The authors find a positive return on the portfolio sorted on relative idiosyncratic volatility or on systematic volatility, but find a negative return sorted on absolute idiosyncratic volatility. The results are robust after controlling for size, BM and other risk characteristics using a double-sorting approach. The Fama–MacBeth regression results show that a positive association between the relative measure and stock returns is driven primarily by the low-systematic-volatility anomaly across firms. The findings are robust to controlling for return residual momentum, skewness, jumps and information discreteness.
Originality/value
Extant research posits the idiosyncratic volatility puzzle and the low-volatility anomaly. The authors emphasize the importance of integrating these two streams of research. This study enhances the understanding of the driving force underlying the relationship between FSRV and cross-sectional stock returns.
Keywords
Acknowledgements
This project is funded by an International Postgraduate Research Scholarship (IPRS) at the University of Western Australia and the National Research Council of Thailand (NRCT): N42A640326. The authors would also like to acknowledge the comments from the participants at the European Financial Management Association 2018 Annual Meeting and the 31st Australasian Finance and Banking Conference.
Citation
Nguyen, H., Lan, Y. and Treepongkaruna, S. (2024), "A closer look at the relationship between firm-specific return variation and stock returns", Journal of Accounting Literature, Vol. 46 No. 2, pp. 277-292. https://doi.org/10.1108/JAL-02-2023-0020
Publisher
:Emerald Publishing Limited
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