Volatility Effects

Conventional wisdom holds that high (low) overall stock market volatility forecasts high (low) stock returns, as a fundamental reward-for-risk phenomenon. In their March 2006 paper entitled “Understanding Stock Return Predictability”, Hui Guo and Robert Savickas investigate a refinement to volatility-based prediction of stock market returns by combining the effects of realized overall market volatility and the average realized idiosyncratic volatility of individual stocks. They theorize that: (1) overall stock market volatility reflects the volatilities of both cash flow shocks and discount rate shocks; (2) overall stock market volatility overstates discount rate shock volatility; and, (3) average idiosyncratic volatility, which reflects the volatility of discount rate shocks only, corrects this overstatement. Using quarterly overall and idiosyncratic volatilities from 1927 through 2005, they conclude that: Keep Reading

We have selected for retrospective review a few all-time “best selling” research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the February 1999 paper entitled “Daily Momentum And Contrarian Behavior Of Index Fund Investors” (download count almost 1,900) by William Goetzmann and Massimo Massa. The authors investigate the existence and profitability of momentum and contrarian behaviors for stock index trading. They classify return momentum investors (trend followers) as those who buy (sell) when the market rises (drops) in the previous trading session, and return contrarian investors as “profit takers” who sell (buy) when the market rises (drops). They also examine investor response to changes in market volatility, defining both volatility momentum traders (risk chasers) and volatility contrarian traders (risk avoiders). Using daily activity records for 91,000 accounts trading an S&P 500 index during 1997 and 1998, the authors find that: Keep Reading

The market rewards investors for taking risk. Right? High volatility means high risk. Right? High volatility therefore means excess return. Right? In their January 2006 paper entitled “High Idiosyncratic Volatility and Low Returns: International and Further U.S. Evidence”, Andrew Ang, Robert Hodrick, Yuhang Xing and Xiaoyan Zhang test the relationship between past idiosyncratic volatility and future returns for stocks in developed markets around the world. Using data from 23 countries mostly over the period January 1980 through December 2003, they find that: Keep Reading

In the September 2005 version of their paper entitled “Investor Recognition and Stock Returns”, Reuven LeHavy and Richard Sloan analyze the relation between how widely a stock is recognized and its returns (past and future). They use change in the proportion of quarterly SEC Form 13-F filers (institutional investment managers who exercise investment discretion over $100 million) holding a stock to represent the change in investor recognition of that stock. Using Form 13-F and stock price data over the period 1982-2004, they find that: Keep Reading