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Comparing different explanations of the volatility trend

Rubin, Amir & Smith, Daniel (2011) Comparing different explanations of the volatility trend. Journal of Banking and Finance, 35(6), pp. 1581-1597.

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Abstract

We analyze the puzzling behavior of the volatility of individual stock returns over the past few decades. The literature has provided many different explanations to the trend in volatility and this paper tests the viability of the different explanations. Virtually all current theoretical arguments that are provided for the trend in the average level of volatility over time lend themselves to explanations about the difference in volatility levels between firms in the cross-section. We therefore focus separately on the cross-sectional and time-series explanatory power of the different proxies. We fail to find a proxy that is able to explain both dimensions well. In particular, we find that Cao et al. [Cao, C., Simin, T.T., Zhao, J., 2008. Can growth options explain the trend in idiosyncratic risk? Review of Financial Studies 21, 2599–2633] market-to-book ratio tracks average volatility levels well, but has no cross-sectional explanatory power. On the other hand, the low-price proxy suggested by Brandt et al. [Brandt, M.W., Brav, A., Graham, J.R., Kumar, A., 2010. The idiosyncratic volatility puzzle: time trend or speculative episodes. Review of Financial Studies 23, 863–899] has much cross-sectional explanatory power, but has virtually no time-series explanatory power. We also find that the different proxies do not explain the trend in volatility in the period prior to 1995 (R-squared of virtually zero), but explain rather well the trend in volatility at the turn of the Millennium (1995–2005).

Impact and interest:

3 citations in Scopus
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3 citations in Web of Science®

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ID Code: 44546
Item Type: Journal Article
Keywords: Volatility, Trend, Turnover
DOI: 10.1016/j.jbankfin.2010.11.001
ISSN: 0378-4266
Subjects: Australian and New Zealand Standard Research Classification > MATHEMATICAL SCIENCES (010000) > APPLIED MATHEMATICS (010200)
Australian and New Zealand Standard Research Classification > COMMERCE MANAGEMENT TOURISM AND SERVICES (150000) > BANKING FINANCE AND INVESTMENT (150200)
Divisions: Current > QUT Faculties and Divisions > QUT Business School
Current > Schools > School of Economics & Finance
Deposited On: 24 Aug 2011 22:12
Last Modified: 29 Feb 2012 14:26

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