A Free Lunch Of Low Risk And High Return?-an Empirical Study Of Idiosyncratic Volatility Anomaly In A Share Market

The notion that taking more risk is necessary to achieve greater returnis deeply ingrained in most investors. Questioning the validity of such adeeply rooted belief may sound like heresy, but multiple researchers anddecades of equity market data show it is possible to achieve the same orbetter return with less risk within an asset class. Andrew Ang, Robert J.Hodrick, Y. Xing and X. Zhang (2006) discover the IdiosyncraticVolatility Puzzle‘in US equity market. He proves that stocks with highidiosyncratic volatility obtain low cross-sectional expected return.This paper studies on the correlation between stock idiosyncraticvolatility and cross-sectional expected return in A share market. It isfound that the idiosyncratic volatility anomaly dose exist in A sharemarket, when using CAPM model to measure stock idiosyncraticvolatility.This paper further tests the explanation power of short sellingconstrains and heterogeneous beliefs on the idiosyncratic volatilitypuzzle‘. It is found that the mitigating limitation on short selling in Ashare market impacted the significance of negative correlation betweenstock idiosyncratic volatility and its expected return. It proves that theheterogeneous beliefs can in certain degree explain the idiosyncraticvolatility anomaly in A share market.