Good Volatility, Bad Volatility and the Expected Stock Returns

Abstract

Based on intraday data for a large cross-section of individual stocks and newly developed econometric procedures, we decompose the realized variation for each of the stocks into separate so-called realized up and down semi-variance measures, or “good” and “bad” volatilities, associated with positive and negative high-frequency price increments, respectively. Sorting the individual stocks into portfolios based on their normalized good minus bad volatilities results in economically large and highly statistically significant differences in the subsequent portfolio returns. These differences remain significant after controlling for other firm characteristics and explanatory variables previously associated with the cross-section of expected stock returns. The results also remain intact in double portfolio sorts designed to control for other high-frequency-based realized variation measures. By contrast, the strong negative association between the realized skewness measure and subsequent returns recently documented by Amaya, Christoffersen, Jacobs, and Vasquez (2016) is completely reversed after controlling for the individual stocks’ relative good minus bad volatility.