Abstract
We construct a risk adjusted version of return reversal within the US stock universe, which we name idiosyncratic Z score (IZ). Stock ranking in the IZ portfolios is based on the ratio of individual stocks’ idiosyncratic return and its idiosyncratic risk. We link IZ with the stocks’ demand shocks that are not information driven – a theory developed by Greenwood (2005). During our study period, the IZ factor exhibits excellent risk adjusted excess return. More importantly, our empirical result shows that there is systematic information embedded in IZ that is independent of other well-known pricing factors like value and momentum. Factor loading of IZ on Fama-French portfolios and industrial portfolios is shown to be statistically significant, and its magnitude is on the same order as SMB and HML factors. Therefore, we do not reject the notion that IZ represents a systematic risk factor that can in part explain the cross section of US stocks’ daily returns. We also experiment with several different schemes to construct the IZ factor and the results remain to be robust.
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