Solving The Volatility Puzzle

One of the interesting puzzles in finance is that stocks with greater idiosyncratic volatility (IVOL) have produced lower returns. This is an anomaly, because idiosyncratic volatility is viewed as a risk factor—greater volatility should be rewarded with higher, not lower, returns.

Robert Stambaugh, Jianfeng Yu and Yu Yuan, authors of the study “Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle,” which appears in the October 2015 issue of The Journal of Finance, provide an explanation—and the evidence supporting it—for why the anomaly persists.

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