Master of Arts, Miami University, 2014, Economics

We use various samples of portfolios (Fama-French portfolios formed on size and book-to-market, Fama-French industry portfolios, and exchange traded funds) as test assets to investigate whether the negative relation between lagged idiosyncratic volatility (IVOL) and future average returns initially documented by Ang, Hodrick, Xing, and Zhang (2006) is due to a missing risk factor. Analytically, we show that if IVOL proxies for a missing risk factor, then the negative relation between IVOL and returns persists at a portfolio level since systematic risk is not eliminated through diversification. However, when we take it to the data, we do not find economically and statistically significant evidence of a relation between lagged IVOL and subsequent average returns. Taken together, our results suggest that the IVOL puzzle is not due to a missing risk factor.

Committee: Haimanot Kassa Ph.D. (Advisor); Tyler Henry Ph.D. (Committee Member); George Davis Ph.D. (Committee Member) Subjects: Economics; Finance