Research On The Idiosyncratic Volatility Puzzle Of Chinese Stock Market

Traditional asset pricing models in which investors hold well-diversified portfolios imply that there should be no relation between the idiosyncratic volatility(IVOL)and the expected returns.Otherwise,there should be positive relation between the idiosyncratic volatility and the expected returns.However,Ang(2006)documents that stocks with high idiosyncratic volatility earn low subsequent returns,there is a negative relation between idiosyncratic volatility and subsequent stock returns.The puzzle that traditional asset pricing theories can’t explain is called the idiosyncratic volatility puzzle.Studies about idiosyncratic volatility puzzle are so much,but there isn’t a normal conclusion.Based on the theory of prospect,this paper uses daily data to calculate idiosyncratic volatility monthly based on the three-factor Fama-French(1993)model,and studies the relationship between expected return of stocks and idiosyncratic volatility from the theoretical and empirical aspects.This paper uses the method of Grinblatt and Han(2005)to calculate a proxy for capital gains individual stocks,this is,stock level CGO,which is the normal diffidence between the current price and the referent price.This paper uses the two-dimensional analysis method and the Fama-Macbeth method to find that the idiosyncratic volatility puzzle really exists in stock market.And when faced with capital gains overhang,idiosyncratic volatility is positive to the expected return;when faced with capital loss overhang,idiosyncratic volatility is negitive to the expected return.It is further proved that when investors are in high sentiment,the inverse relationship between idiosyncratic volatility and expected return becomes more obvious,but the positive relationship will be weakened.Based on prospect theory,when faced with gains,investors are risk averse;when faced with loss,investors are risk seeking.So reference-dependent preference is the most promising explanation to the idiosyncratic volatility puzzle.