The Idiosyncratic Volatility Puzzle

Monthly sorting stocks into quintiles based on idiosyncratic volatility levels we find a negative relationship between idiosyncratic volatility and returns, providing additional evidence of the Idiosyncratic Volatility Puzzle after the crisis in the American equity market. We test several holding periods (1, 3, 6 and 12 months) finding that the relation between idiosyncratic volatility and returns is holding-period dependent, because it presents an inverted U-shape trend. A wavelet multi-resolution analysis performed on our data shows the contribution of different frequencies to the Puzzle, reporting the relevance of heterogeneity of investors’ investment horizon hypothesis. Several performance evaluation measures are then computed for two trading strategies exploiting the Puzzle.