Price informativeness: a potential explanation for the idiosyncratic volatility puzzle

ABSTRACT

Price informativeness is the amount of private information incorporated into stock prices and measured by $R^2$ from regressions of stock returns on systematic risk factors. While $R^2$ is closely related with idiosyncratic volatility, it is not interchangeable because magnitude of systematic volatility simultaneously changes. By controlling for the systematic volatility using the double-sorting portfolio approach, we suggest a potential involvement of price informativeness with the idiosyncratic volatility puzzle. Both cross-sectional evidence of monotonic and inverse relationship between idiosyncratic volatility and $R^2$ and time-series evidence of disappearing alphas of the low-minus-high idiosyncratic volatility portfolios during recessions support an explanation of the idiosyncratic volatility puzzle in association with price informativeness.

KEYWORDS:

• Idiosyncratic volatility puzzle
• R²
• price informativeness
• systemic volatility

JEL CLASSIFICATION:

• G12
• G14

Disclosure statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Additional information

Funding

This work was supported by Hankuk University of Foreign Studies Research Fund.