Retail investor preferences and the idiosyncratic volatility puzzle

Research output: Contribution to journalArticleResearchpeer-review

Abstract

We explain the negative relation between idiosyncratic volatility and future stock returns observed by previous researchers. We argue that, based on the observation described in prospect theory, retail investors prefer stocks with a high level of idiosyncratic volatility and are consequently willing to overpay for those stocks. In support of our argument, we find that the negative idiosyncratic-volatility return relation is present in the Australian market, and that this relation is affected by the magnitude of retail trading. The relation is particularly strong when returns and realized volatility are measured at a daily frequency.
Original languageEnglish
Pages (from-to)45-53
Number of pages9
JournalAcademy of Taiwan Business Management Review
Volume10
Issue number3
Publication statusPublished - 2014

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Investors
Idiosyncratic volatility
Retail
Stock returns
Prospect theory
Return volatility
Realized volatility

Cite this

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title = "Retail investor preferences and the idiosyncratic volatility puzzle",
abstract = "We explain the negative relation between idiosyncratic volatility and future stock returns observed by previous researchers. We argue that, based on the observation described in prospect theory, retail investors prefer stocks with a high level of idiosyncratic volatility and are consequently willing to overpay for those stocks. In support of our argument, we find that the negative idiosyncratic-volatility return relation is present in the Australian market, and that this relation is affected by the magnitude of retail trading. The relation is particularly strong when returns and realized volatility are measured at a daily frequency.",
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Retail investor preferences and the idiosyncratic volatility puzzle. / Henker, Julia; Henker, Thomas; Tan, Deborah.

In: Academy of Taiwan Business Management Review, Vol. 10, No. 3, 2014, p. 45-53.

Research output: Contribution to journalArticleResearchpeer-review

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AB - We explain the negative relation between idiosyncratic volatility and future stock returns observed by previous researchers. We argue that, based on the observation described in prospect theory, retail investors prefer stocks with a high level of idiosyncratic volatility and are consequently willing to overpay for those stocks. In support of our argument, we find that the negative idiosyncratic-volatility return relation is present in the Australian market, and that this relation is affected by the magnitude of retail trading. The relation is particularly strong when returns and realized volatility are measured at a daily frequency.

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