Abstract
We unveil a theoretical link between the portfolio excess growth rate (EGR) and two measures of average idiosyncratic volatility (IdVol) and confirm it empirically for the U.S. equity market. We find that the EGR and average IdVol are positively related with subsequent market returns over short horizons. A theoretical analysis of EGR properties explains why the relationship between average IdVol and future portfolio returns changes for different weighting schemes, horizons, and portfolio rebalancing frequencies. Furthermore, it explains why the outperformance of low versus high IdVol portfolios is completely reversed at higher rebalancing frequencies when using equal weights.
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