Journal article
Firm Disclosures, Uncertain Profits, and (Indirectly) Priced Idiosyncratic Volatility
Journal of business finance & accounting, Vol.52(5), pp.2415-2437
11/2025
DOI: 10.1111/jbfa.70004
Abstract
We show that the negative relation between idiosyncratic volatility (IVOL) and expected returns exists only among firms with low profitability and high uncertainty about profitability. We propose an incomplete information model in which agents cannot disentangle systematic from idiosyncratic shocks. While not priced directly, IVOL affects expected returns by lowering signal accuracy, which decreases the factor loading on the systematic risk and yields the negative IVOL‐return relation. The model predicts that this negative relation is the strongest among underperforming firms with highly uncertain profitability. Our model effectively explains a significant portion of the observed negative IVOL‐return relation (86%) in the data.
Details
- Title: Subtitle
- Firm Disclosures, Uncertain Profits, and (Indirectly) Priced Idiosyncratic Volatility
- Creators
- Xuhui (Nick) Pan - University of OklahomaBharat Raj Parajuli - Monash UniversityPetra Sinagl - University of Iowa
- Resource Type
- Journal article
- Publication Details
- Journal of business finance & accounting, Vol.52(5), pp.2415-2437
- DOI
- 10.1111/jbfa.70004
- ISSN
- 0306-686X
- eISSN
- 1468-5957
- Publisher
- Wiley; HOBOKEN
- Grant note
We are grateful to Peter Pope (the editor) and the anonymous referee for their helpful and constructive suggestions. We thank David Bates, Tarun Chordia, Jon Garfinkel, Kewei Hou, Lubomir Litov, Roger Loh, Ashish Tiwari, Pradeep Yadav, Tong Yao, and seminar participants at the University of Iowa and the University of Oklahoma for valuable feedback.
- Language
- English
- Electronic publication date
- 08/05/2025
- Date published
- 11/2025
- Academic Unit
- Finance
- Record Identifier
- 9984944723702771
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