Abstract
Recent studies find stock returns are negatively related to idiosyncratic volatility (IVOL). We find that aggregate variables known to explain stock market volatility affect the IVOL and portfolio returns sorted by IVOL. Macroeconomic volatilities, yield spreads, dividend yield, trading volume and common factors of earnings forecast dispersions are important drivers of IVOL. Macro factors produce the negative pattern, consistent with theories of intertemporal hedging demand. Teasing out the common IVOL part, the residual IVOL is positively and significantly related to stock returns and the idiosyncratic portions of earnings forecast dispersions. This is consistent with ambiguity aversion and incomplete market hypotheses.
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