Idiosyncratic volatility, network centrality, and stock returns

Abstract

To study interconnectedness in the stock market and examine the impact of network centrality on stock returns, this study constructs a network of Turkish stocks based on idiosyncratic volatility correlations. We find that the book-to-market ratio and market size are negatively associated with network centrality, whereas idiosyncratic volatility and trading volume are positively associated with it. Furthermore, we show that the centrality factor can explain stock returns in the Turkish stock exchange better than size and value factors. The inclusion of the centrality factor increases R2 by as much as twenty percentage points. Furthermore, we find that higher network centrality scores can predict higher future stock returns, even when size, the book-to-market ratio, idiosyncratic volatility, trading volume, and lagged returns are controlled for. We also find a positive relationship between one-month-lagged idiosyncratic volatility and stock returns and show that this relationship is stronger for less visible stocks.