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Diversification and idiosyncratic volatility puzzle: Evidence from ETFs

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  • Duanmu, Jun
  • Hur, Jungshik
  • Li, Yongjia

Abstract

Exchange Traded Funds (ETFs) are considered diversified portfolios with low transaction costs and high liquidity. We test the impact of idiosyncratic risk on the cross-sectional returns of ETFs. We find the magnitude of idiosyncratic risk for U.S. equity ETFs is less than half of that of the sector equity ETFs. We show evidence that the idiosyncratic volatility (IVOL) puzzle only exists for sector equity ETFs, albeit they have a significant number of constituents. These findings are robust to ETF price, size, liquidity, different idiosyncratic risk estimates, and the subset of ETFs with a large number of constituents.

Suggested Citation

  • Duanmu, Jun & Hur, Jungshik & Li, Yongjia, 2024. "Diversification and idiosyncratic volatility puzzle: Evidence from ETFs," Research in International Business and Finance, Elsevier, vol. 71(C).
    • Handle: RePEc:eee:riibaf:v:71:y:2024:i:c:s0275531924002368
    DOI: 10.1016/j.ribaf.2024.102443
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    More about this item

    Keywords

    Idiosyncratic volatility puzzle; Exchange Traded Funds (ETFs); Diversification;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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