Asset Growth and Idiosyncratic Return Volatility *

Abstract

This article studies the empirical relationship between firms’ asset growth and idiosyncratic stock return volatility. In the cross-section, firms’ idiosyncratic return volatility is V-shaped with respect to their lagged asset growth rates: the volatility is higher for firms with extreme (either high or low) asset growth rates than for firms with moderate growth rates. In the time series, a higher dispersion across firms in asset growth rates predicts a higher average idiosyncratic return volatility. Moreover, the dispersion in asset growth rates has the strongest time series predictive power among alternative explanations of the average idiosyncratic return volatility, such as cash flow volatility and growth options. These findings indicate the importance of nonlinearity in studying the cross-sectional return volatility and provide a new explanation of the idiosyncratic return volatility that is significant in both the cross-section and the time series.