Idiosyncratic Volatility Puzzle: Influence of Macro-Finance Factors

In this paper, we scrutinize the cross-sectional relation between idiosyncratic volatility and stock returns. As a novelty, the idiosyncratic volatility is obtained by conditioning upon macro-finance factors as well as upon traditional asset pricing factors. The macro-finance factors are constructed from a large pool of macroeconomic and financial variables. Cleaning for macro-finance e§ects reverses the puzzling negative relation between returns and idiosyncratic volatility documented previously. Portfolio analysis shows that the effects from macro-finance factors are economically strong. The relation between idiosyncratic volatility and returns does not vary with the NBER business cycles. The empirical results are highly robust. Keywords: Idiosyncratic volatility puzzle; Macro-finance predictors; Factor analysis; Business cycle. JEL Classifications: G12; G14

Idiosyncratic volatility around information release date

Several papers document idiosyncratic volatility is time-varying and many attempts have been made to reveal whether idiosyncratic risk is priced. This research studies behavior of idiosyncratic volatility around information release dates and also its relation with return after public announcement. The results indicate that when a company discloses specific information to the market, firm’s specific volatility level shifts and short-horizon event-induced volatility vary significantly however, the category to which the announcement belongs is not important in magnitude of change. This event-induced volatility is not small in size and should not be downplayed in event studies. Moreover, this study shows stocks with higher contemporaneous realized idiosyncratic volatility earn lower return after public announcement consistent with “divergence of opinion hypothesis”. While no significant relation is found between EGARCH estimated idiosyncratic volatility and return and also between one-month lagged idiosyncratic volatility and return presumably due to significant jump around public announcement both may provide some signals regarding future idiosyncratic volatility through their correlations with contemporaneous realized idiosyncratic volatility. Finally, the study show that positive relation between return and idiosyncratic volatility based on under-diversification is inadequate to explain all different scenarios and this negative relation after public announcement may provide a useful trading rule.

Exact Skewness-Kurtosis Tests for Multivariate Normality and Goodness-of-fit in Multivariate Regressions with Application to Asset Pricing Models

We study the problem of testing the error distribution in a multivariate linear regression (MLR) model. The tests are functions of appropriately standardized multivariate least squares residuals whose distribution is invariant to the unknown cross-equation error covariance matrix. Empirical multivariate skewness and kurtosis criteria are then compared to simulation-based estimate of their expected value under the hypothesized distribution. Special cases considered include testing multivariate normal, Student t; normal mixtures and stable error models. In the Gaussian case, finite-sample versions of the standard multivariate skewness and kurtosis tests are derived. To do this, we exploit simple, double and multi-stage Monte Carlo test methods. For non-Gaussian distribution families involving nuisance parameters, confidence sets are derived for the the nuisance parameters and the error distribution. The procedures considered are evaluated in a small simulation experi-ment. Finally, the tests are applied to an asset pricing model with observable risk-free rates, using monthly returns on New York Stock Exchange (NYSE) portfolios over five-year subperiods from 1926-1995.

Cross–Sectoral Variation in Firm–Level Idiosyncratic Risk

We estimate firm–level idiosyncratic risk in the U.S. manufacturing sector. Our proxy for risk is the volatility of the portion of growth in sales or TFP which is not explained by either industry– or economy–wide factors, or firm characteristics systematically associated with growth itself. We find that idiosyncratic risk accounts for about 90% of the overall uncertainty faced by firms. The extent of cross–sectoral variation in idiosyncratic risk is remarkable. Firms in the most volatile sector are subject to at least three times as much uncertainty as firms in the least volatile. Our evidence indicates that idiosyncratic risk is higher in industries where the extent of creative destruction is likely to be greater.

Cross-sectoral variation in the volatility of plant-level idiosyncratic shocks

We estimate the volatility of plant–level idiosyncratic shocks in the U.S. manufacturing sector. Our measure of volatility is the variation in Revenue Total Factor Productivity which is not explained by either industry– or economy–wide factors, or by establishments’ characteristics. Consistent with previous studies, we find that idiosyncratic shocks are much larger than aggregate random disturbances, accounting for about 80% of the overall uncertainty faced by plants. The extent of cross–sectoral variation in the volatility of shocks is remarkable. Plants in the most volatile sector are subject to about six times as much idiosyncratic uncertainty as plants in the least volatile. We provide evidence suggesting that idiosyncratic risk is higher in industries where the extent of creative destruction is likely to be greater.

Cross-sectional dependence in idiosyncratic volatility

This paper introduces a framework for analysis of cross-sectional dependence in the idiosyncratic volatilities of assets using high frequency data. We first consider the estimation of standard measures of dependence in the idiosyncratic volatilities such as covariances and correlations. Next, we study an idiosyncratic volatility factor model, in which we decompose the co-movements in idiosyncratic volatilities into two parts: those related to factors such as the market volatility, and the residual co-movements. When using high frequency data, naive estimators of all of the above measures are biased due to the estimation errors in idiosyncratic volatility. We provide bias-corrected estimators and establish their asymptotic properties. We apply our estimators to high-frequency data on 27 individual stocks from nine different sectors, and document strong cross-sectional dependence in their idiosyncratic volatilities. We also find that on average 74% of this dependence can be explained by the market volatility.

The effect of skewness and kurtosis on the Kenward-Roger approximation when group distributions differ

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Autoregressive conditional kurtosis

This article proposes a new model for autoregressive conditional heteroscedasticity and kurtosis. Via a time-varying degrees of freedom parameter, the conditional variance and conditional kurtosis are permitted to evolve separately. The model uses only the standard Student’s t-density and consequently can be estimated simply using maximum likelihood. The method is applied to a set of four daily financial asset return series comprising U.S. and U.K. stocks and bonds, and significant evidence in favor of the presence of autoregressive conditional kurtosis is observed. Various extensions to the basic model are proposed, and we show that the response of kurtosis to good and bad news is not significantly asymmetric.

Idiosyncratic volatility and the pricing of poorly-diversified portfolios

This article examines the role of idiosyncratic volatility in explaining the cross-sectional variation of size- and value-sorted portfolio returns. We show that the premium for bearing idiosyncratic volatility varies inversely with the number of stocks included in the portfolios. This conclusion is robust within various multifactor models based on size, value, past performance, liquidity and total volatility and also holds within an ICAPM specification of the risk–return relationship. Our findings thus indicate that investors demand an additional return for bearing the idiosyncratic volatility of poorly-diversified portfolios.

Microeconomic instability and children's human capital accumulation: the effects of idiosyncratic shocks to father's income on child labor, school drop-outs and repetition rates in Brazil

This paper evaluates the long-run effects of economic instability. In particular, we study the impact of idiosyncratic shocks to father’s income on children’s human capital accumulation variables such as school drop-outs, repetition rates and domestic and non-domestic labor. Although, the problem of child labor in Brazil has declined greatly during the last decade, the number of children working is still substantial. The low levels of educational attainment in Brazil are also a main cause for concern. The large rotating panel data set used allows for the estimation of the impacts of changes in occupational and income status of fathers on changes in his child’s time allocation circumstances. The empirical analysis is restricted to families with fathers, mothers and at least one child between 10 and 15 years of age in the main Brazilian metropolitan areas during the 1982-1999 period. We perform logistic regressions controlling for child characteristics (gender, age, if he/she is behind in school for age), parents characteristics (grade attainment and income) and time and location variables. The main variables analyzed are dynamic proxies of impulses and responses, namely: shocks to household head’s income and unemployment status, on the one hand and child’s probability of dropping out of school, of repeating a grade and of start working, on the other. The findings suggest that father’s income has a significant positive correlation with child’s dropping out of school and of repeating a grade. The findings do not suggest a significant relationship between a father’s becoming unemployed and a child entering the non-domestic labor market. However, the results demonstrate a significant positive relationship between a father becoming unemployed and a child beginning to work in domestic labor. There was also a positive correlation between father becoming unemployed and a child dropping out and repeating a grade. Both gender and age were highly significant with boys and older children being more likely to work, drop-out and repeat grades.

Evolutionary History of the PER3 Variable Number of Tandem Repeats (VNTR): Idiosyncratic Aspect of Primate Molecular Circadian Clock

Fundação de Amparo à Pesquisa do Estado de São Paulo (FAPESP)

"Leiomyomatoid angiomatous neuroendocrine tumor" (LANT) of the pituitary reflects idiosyncratic angiogenesis in adenomas of the gonadotroph cell lineage.

Based on a single-case observation, the descriptive label "leiomyomatoid angiomatous neuroendocrine tumor" (LANT) has been tentatively applied to what was perceived as a possible novel type of dual-lineage pituitary neoplasm with biphasic architecture. We report on two additional examples of an analogous phenomenon encountered in male patients, aged 59 years (Case 1) and 91 years (Case 2). Both tumors were intra- and suprasellar masses, measuring 5.6 cm × 4.4 cm × 3.4 cm, and 2.7 cm × 2 cm × 1.7 cm, respectively. Histologically, Case 1 was an FSH-cell adenoma interwoven by vascularized connective tissue septa that tended to exhibit incremental stages of adventitial overgrowth. The epithelial component of Case 2 corresponded to an LH-cell adenoma, and lay partitioned by a maze of paucicellular to hyalinized vascular axes. Irrespective of architectural variations, perivascular spindle cells exhibited immunopositivity for vimentin, muscular actin, and smooth muscle actin. Conversely, negative results were obtained for CD34, EMA, S100 protein, GFAP, and TTF-1. Ultrastructural study failed to reveal metaplastic cell forms involving transitional features between adenohypophyseal-epithelial and mesenchymal-contractile phenotype. We propose that LANT be regarded as a peculiar reflection of maladaptive angiogenesis in some pituitary adenomas, rather than a genuine hybrid neoplasm. While no mechanistic clue is forthcoming to account for this distinctive pattern, hemodynamic strain through direct arterial - rather than portal - supply of the adenoma's capillary bed may be one such explanatory factor. The apparent predilection of the LANT pattern for macroadenomas of the gonadotroph cell lineage remains unexplained.