a1 Eller College of Management, University of Arizona, PO Box 210108, Tucson, AZ 85721. email@example.com
a2 School of Business Administration, Gonzaga University, 502 E. Boone Ave., Spokane, WA 99258. firstname.lastname@example.org
a3 Tippie College of Business, University of Iowa, 108 John Pappajohn Business Bldg., Iowa City, IA 52242. email@example.com
Ang, Hodrick, Xing, and Zhang (2006a) show that stocks with high idiosyncratic return volatility tend to have low future returns. This paper further documents that idiosyncratic volatility is inversely related to future earning shocks, and more importantly, that the return-predictive power of idiosyncratic volatility is induced by its information content about future earnings. We examine various explanations of the triangular relation among idiosyncratic volatility, future earning shocks, and future stock returns. Our results show that the idiosyncratic volatility anomaly is not a simple manifestation of previously documented market anomalies related to excessive extrapolation on firm growth, over-investment tendency, accounting accruals, or investor underreaction to earnings news. On the other hand, there is evidence that the idiosyncratic volatility anomaly is related to corporate selective disclosure, and the anomaly is stronger among stocks with a less sophisticated investor base.
We thank Andrew Ang (associate editor and referee), Hendrik Bessembinder (the editor), Tyler Brough, Jean Helwege, Guo Hui, Vince Intintoli, Paul Irvine, Chris Jones, Kathy Kahle, Chris Lamoureux, Sonya Lim (FMA discussant), Ken Roskelley, Robert Savickas, Grant Wang, and seminar participants at the University of Arizona, the 2005 Annual Meetings of the Financial Management Association in Chicago, and the 2006 Northern Finance Association Meetings in Montreal for helpful comments and suggestions.