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Idiosyncratic Volatility of Small Public Firms and Entrepreneurial Risk

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  • David P. Brown

    (University of Wisconsin-Madison, School of Business, Grainger Hall, 975 University Avenue, Madison, WI 53706, USA)

  • Miguel A. Ferreira

    (Nova School of Business and Economics, Faculdade de Economia, Campus de Campolide, 1099-032 Lisboa, Portugal)

Abstract

The average idiosyncratic volatility of small public firms is a positive predictor of future stock returns. This is true for returns of both large and small firms. We consider several economic arguments for this result, including a liquidity premium, and we rule out all but one of them. Our evidence supports the entrepreneurial risk hypothesis, which states that small firms’ idiosyncratic risk is a proxy for risk faced by private business owners, who also happen to be significant shareholders of stock. Expected returns are increasing functions of entrepreneurial risk, and therefore returns are predictable using proxies for this risk, which include small-firm idiosyncratic volatility.

Suggested Citation

  • David P. Brown & Miguel A. Ferreira, 2016. "Idiosyncratic Volatility of Small Public Firms and Entrepreneurial Risk," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 6(01), pages 1-59, March.
    • Handle: RePEc:wsi:qjfxxx:v:06:y:2016:i:01:n:s2010139216500026
    DOI: 10.1142/S2010139216500026
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