Date of this Version
The Journal of Finance
Buying is easier than shorting for many equity investors. Combining this arbitrage asymmetry with the arbitrage risk represented by idiosyncratic volatility (IVOL) explains the negative relation between IVOL and average return. The IVOL-return relation is negative among overpriced stocks but positive among underpriced stocks, with mispricing determined by combining 11 return anomalies. Consistent with arbitrage asymmetry, the negative relation among overpriced stocks is stronger, especially for stocks less easily shorted, so the overall IVOL-return relation is negative. Further supporting our explanation, high investor sentiment weakens the positive relation among underpriced stocks and, especially, strengthens the negative relation among overpriced stocks.
This is the peer reviewed version of the following article: STAMBAUGH, R. F., YU, J. and YUAN, Y. (2015), Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle. The Journal of Finance, 70: 1903–1948. doi:10.1111/jofi.12286, which has been published in final form at http://dx.doi.org/10.1111/jofi.12286. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving http://olabout.wiley.com/WileyCDA/Section/id-820227.html#terms
Stambaugh, R. F., Yu, J., & Yuan, Y. (2015). Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle. The Journal of Finance, 70 (5), 1903-1948. http://dx.doi.org/10.1111/jofi.12286
Date Posted: 27 November 2017
This document has been peer reviewed.