Asia-Pacific Journal of Business (아태비즈니스연구)

KNU The Institute of Management & Economy Research (강원대학교 경영경제연구소)
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Is The Idiosyncratic Volatility Puzzle Driven By A Missing Factor?

  • Hanjun Kim (David Eccles School of Business, University of Utah) ;
  • Bumjean Sohn (Korea University Business School, Korea University)
  • Received : 2024.02.29
  • Accepted : 2024.03.24
  • Published : 2024.03.31
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Abstract

Purpose - We investigate whether a potential missing pricing factor plays a significant role in the idiosyncratic volatility puzzle. Design/methodology/approach - We theoretically show how a missing pricing factor can affect the idiosyncratic volatility puzzle, and also show how to get around the problem empirically. We adopt the Fama-French five factor model for the estimation of the idiosyncratic risk and use randomly constructed portfolios as test assets. Findings - We find that a missing factor does not drive the idiosyncratic volatility puzzle. Thus, we conclude that the idiosyncratic volatility does affect the risk premium of its stock. Research implications or Originality - The Fama-French five factor model does a pretty good job in explaining the risk premiums of stocks, and it can be used to reliably estimate idiosyncratic risk of stocks.

Keywords

Acknowledgement

This work was supported by Korea University Business School Research Fund of 2023.

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