Journal of Financial and Quantitative Analysis Vol. 49 No. 5-6 2014
A Model-Free Measure of Aggregate Idiosyncratic Volatility and the Prediction of Market Returns
Abstract
In this paper, we formally show that the cross-sectional variance of stock returns is a consistent and asymptotically efficient estimator for aggregate idiosyncratic volatility. This measure has two key advantages: It is model free and observable at any frequency. Previous approaches have used monthly model-based measures constructed from time series of daily returns. The newly proposed cross-sectional volatility measure is a strong predictor for future returns on the aggregate stock market at the daily frequency. Using the cross section of size and book-to-market portfolios, we show that the portfolios’ exposures to the aggregate idiosyncratic volatility risk predict the cross section of expected returns.
- DOI
- 10.1017/s0022109014000489
- Volume
- 49
- Issue
- 5-6
- Pages
- 1133-1165
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref