Are idiosyncratic risk and extreme positive return priced in the Indian equity market?

Abstract

In this paper, we examine whether the IVOL (Idiosyncratic Volatility) and MAX (Extreme Positive Return) can predict future returns in the Indian stock market where a short sale is restricted with no naked short sale allowed. We find that both IVOL and MAX have significantly positive and persistent effects on expected returns in this market. In subsamples, we document that small firms have positive IVOL and MAX effects. However, more interestingly, after including all the controls, in contrast to the finding of Bali et al. (2011), the IVOL and MAX effects are significantly negative for the large firms in this market implying the investors’ response to IVOL and MAX with the perception of low growth prospects of large firms. We use both portfolio level and firm level Fama Macbeth cross-sectional analysis to show the effects.