Abstract
We investigate the empirical implications of investors’ heterogeneous preferences for skewness with respect to the idiosyncratic volatility (IV) puzzle (the negative correlation between idiosyncratic volatility and mean returns). We show that the IV puzzle is stronger (1) within those stocks held primarily by agents with preference for lottery-like payoffs and (2) during economic downturns, when the demand for lottery-like payoffs is high. These results support recent theories that suggest lottery preferences may be a significant source of the IV puzzle.
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