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Exploring the Nonlinear Idiosyncratic Volatility Puzzle: Evidence from China

Author

Listed:
  • Bo Li

    (Beijing International Studies University)

  • Sabri Boubaker

    (Métis Lab
    Vietnam National University)

  • Zhenya Liu

    (Renmin University of China
    Renmin University of China
    Aix-Marseille University)

  • Waël Louhichi

    (ESSCA School of Management)

  • Yao Yao

    (University of Birmingham)

Abstract

This paper studies the spectrum of the idiosyncratic volatility (IVOL) puzzle in the Chinese A-share market using functional data analysis (FDA). It highlights a nonlinear IVOL puzzle with a steady reduction in the bottom 20% of average returns and a large drop of 1% in the top 10%, consistent with the herding, certainty, and reflection effects in China’s A-share markets. Furthermore, empirical evidence suggests that the FDA technique has a 30% greater goodness of fit than linear regressions, suggesting that nonlinearity plays a non-negligible role in the IVOL puzzle. These results can be useful for investors and hedgers, as they show that stock returns decline accelerated as the IVOL increases.

Suggested Citation

  • Bo Li & Sabri Boubaker & Zhenya Liu & Waël Louhichi & Yao Yao, 2023. "Exploring the Nonlinear Idiosyncratic Volatility Puzzle: Evidence from China," Computational Economics, Springer;Society for Computational Economics, vol. 62(2), pages 527-559, August.
    • Handle: RePEc:kap:compec:v:62:y:2023:i:2:d:10.1007_s10614-022-10265-3
    DOI: 10.1007/s10614-022-10265-3
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    More about this item

    Keywords

    Idiosyncratic volatility puzzle; Portfolio-based approach; Functional data analysis; China’s A-share markets;
    All these keywords.

    JEL classification:

    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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