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Reinvestigate the Bid–Ask Bounce Effect and Pricing of Idiosyncratic Volatility: The Case of the Australian Market

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  • Bin Liu

    (School of Accounting, Economics and Finance, University of Wollongong, NSW 2522, Australia)

  • Monica Tan

    (School of Economics, Finance and Marketing, RMIT University, VIC 3000, Australia)

  • Marie-Anne Cam

    (School of Economics, Finance and Marketing, RMIT University, VIC 3000, Australia)

Abstract

We investigate the bid–ask bounce effect on estimation of idiosyncratic volatility (IVOL) from asset pricing perspective using a comprehensive country-specific sample. We find that the idiosyncratic volatility–return relationship remains significant while controlling for stock size. However, the explanatory power of IVOL disappears completely when stock liquidity is controlled for. These findings support our argument that the bid–ask bounce effect on pricing of IVOL is strongly influenced by stock liquidity. Our results indicate that mid-price is the “true” price to measure IVOL of the least liquid stocks in the Australian stock market.

Suggested Citation

  • Bin Liu & Monica Tan & Marie-Anne Cam, 2019. "Reinvestigate the Bid–Ask Bounce Effect and Pricing of Idiosyncratic Volatility: The Case of the Australian Market," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 22(01), pages 1-23, March.
    • Handle: RePEc:wsi:rpbfmp:v:22:y:2019:i:01:n:s0219091519500048
    DOI: 10.1142/S0219091519500048
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