Abstract

This study investigates the relation between idiosyncratic volatility and future returns around the firm-specific news announcements in the Korean stock market from July 1995 to June 2018. The excess returns of decile portfolios that are formed by sorting the stocks based on news and non-news idiosyncratic volatility measures. The Fama and French three-factor model is also examined to see whether systematic risk affects news and non-news idiosyncratic volatility profits. The pricing of our news and non-news idiosyncratic volatility are confirmed in the cross-sectional regression using the Fama and MacBeth method. Market beta, size, book to market, momentum, liquidity, and maximum return are controlled to determine robustness. Our empirical evidence suggests that the pricing of the non-news idiosyncratic volatility is more strongly negative compared to the news idiosyncratic volatility, which is contrary to the limited arbitrage explanation for the negative price of the idiosyncratic volatility. We find that the non-news idiosyncratic volatility has a robust negative relation to returns in non-January months. Macro-finance factors drive the conditioned on the missing risk factor hypothesis, the pricing of idiosyncratic volatility. This study contributes to a better understanding of the role of the conditional idiosyncratic volatility in asset pricing. As the Korean stocks provide a fresh sample, our non-U.S. investigation delivers a useful out-of-sample test on the pervasiveness of the non-news volatility effect across the emerging markets.

Highlights

  • Idiosyncratic volatility (IV) has been recently well documented in the field of empirical finance

  • The portfolio-level analysis is firstly conducted to investigate the relationship between the idiosyncratic volatility or the news idiosyncratic volatility and the non-news idiosyncratic volatility in the Korean stock market

  • This study investigates the effect of firm-specific news on the idiosyncratic volatility and future return relationship in the Korean stock market from July 1995 to June 2018

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Summary

Introduction

Idiosyncratic volatility (IV) has been recently well documented in the field of empirical finance. Empirical results on the nature of the idiosyncratic volatility and future return are mixed and show the significantly negative to the insignificant or significant positive relationship (see [1–6]) Of these studies on the relationship between IV and expected returns, Ang et al [1, 7] have received a lot of attention. The short-sale constraints were reported to keep an important role in the IV puzzle explanation [11] This is the most promising interpretation of the negative price relation and the “mispricing-correction” stemming from the idiosyncratic volatility limited arbitrage. Regarding the empirical tests, results reported by DeLisle et al [14] are reverse of the mispricing correction hypothesis for the negative price of idiosyncratic volatility, stating that the non-news volatility is priced more strongly than news volatility. The non-news volatility is strongly significantly negative, which seems to violate the established features of the mispricing correction hypothesis

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