A0701
Title: Idiosyncratic volatility and the consistency of the ICAPM
Authors: Gang Li - The Chinese University of Hong Kong (Hong Kong) [presenting]
Bing Han - University of Toronto (Canada)
Abstract: The average stock return idiosyncratic volatility is shown to contain useful information about the hedge portfolio under the ICAPM. In time series, two different weighted averages of individual stock idiosyncratic volatility together can significantly predict stock market returns over both short- and long-term horizons, both in-sample and out-of-sample. In cross-section, we propose a new method to estimate individual stock exposure to the unobserved hedge portfolio using aggregate idiosyncratic volatilities and find that the estimated beta is significantly related to the cross-section of expected stock returns. Finally, we show both theoretically and empirically that the return predictability of a previous tail index can be explained by idiosyncratic volatility under the ICAPM. Our results support the ICAPM pricing linkage between the time series and cross-section of stock returns.
