Abstract
Roll (1988) finds that idiosyncratic influences strongly dominate systematic influences in stock returns. However, it is extensively debated that whether the prevailing idiosyncratic influences are due to firm-specific information or noise. In this paper, I empirically address this question by examining the contribution of the proxies of private information, public information and noise to the variation of idiosyncratic volatility. My empirical findings suggest that the amount of private information incorporated in the prices strongly dominates public information and noise in driving variation of idiosyncratic volatility. Furthermore, the explanatory power of noise for idiosyncratic volatility decreases with the horizon over which returns are measured. The findings in this paper support the information-based interpretation of idiosyncratic volatility that prices of stocks with greater idiosyncratic volatility are more informative.
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