Review of Finance Vol. 28 No. 5 2024

Hedge funds and the positive idiosyncratic volatility effect

Turan G. Bali¹; Florian Weigert²

¹ McDonough School of Business, Georgetown University , Washington D.C., · ² Institute of Financial Analysis, University of Neuchâtel, Switzerland and Centre for Financial Research, Cologne ,

Abstract

While it is established that idiosyncratic volatility is negatively priced in the cross-section of stock returns, the relation between idiosyncratic volatility and hedge fund returns is largely unexplored. We document that hedge funds with high idiosyncratic volatility earn higher future risk-adjusted returns of 6 percent p.a. than hedge funds with low idiosyncratic volatility. The outperformance arises because hedge funds trade high idiosyncratic volatility stocks wisely. They pick high volatility stocks when they are underpriced and short-sell high volatility stocks when they are overpriced. Our results support the notion that hedge funds’ idiosyncratic volatility is a measure of managerial skill.

DOI

10.1093/rof/rfae022

Volume

28

Issue

5

Pages

1611-1661

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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