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Idiosyncratic Volatility and Cross-Section of Expected Returns: Using the Carhart(1997) four-factor model

  • Journal of Insurance and Finance
  • 2018, 29(1), pp.63-92
  • DOI : 10.23842/jif.2018.29.1.003
  • Publisher : Korea Insurance Research Institute
  • Research Area : Social Science > Business Management
  • Received : November 17, 2017
  • Accepted : February 8, 2018
  • Published : February 28, 2018

Youngkyung Ok 1 Jungmu Kim 1

1영남대학교

Accredited

ABSTRACT

We examine the effect of idiosyncratic volatility on expected returns using daily data for common stocks listed on Korean Stock Exchange for the period of January 2000 to December 2015. In particular, we estimate idiosyncratic volatility based on the Carhart(1997) four-factor model in order to control for momentum, a systematic risk for the post-2000 period. Methodology and main findings are as follows. First, although the value-weighted average return differential between the lowest and highest idiosyncratic volatility portfolios is approximately –1.15% per month, the risk-adjusted return is approximately –0.71% per month yet statistically insignificant. Second, we conduct a double-sort portfolio analysis to control for potential effects of firm characteristics. After controlling for turnover, the trading strategy yields –0.86% per month on average, but risk-adjusted return decreases to –0.43% insignificant. Finally, we run Fama and MacBeth(1973) regressions to control for various firm characteristics at the portfolio level. While Idiosyncratic volatility account for the cross-section of returns on idiosyncratic volatility sorts, it becomes insignificant when controlling for turnover. Our findings suggest that there is no robust evidence of a negative relation between idiosyncratic volatility relative to the Carhart(1997) four-factor model and expected returns and that the relationship highly relies on liquidity.

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