Strategic risk shifting and the idiosyncratic volatility puzzle: An empirical investigation

Zhiyao Chen; Ilya A. Strebulaev; Yuhang Xing; Xiaoyan Zhang

doi:10.1287/mnsc.2020.3593

Strategic risk shifting and the idiosyncratic volatility puzzle: An empirical investigation

Zhiyao Chen, Ilya A. Strebulaev, Yuhang Xing, Xiaoyan Zhang

Research output: Journal Publications and Reviews › RGC 21 - Publication in refereed journal › peer-review

8 Citations (Scopus)

Abstract

We find strong empirical support for the risk-shifting mechanism to account for the puzzling negative relation between idiosyncratic volatility and future stock returns. First, equity holders take on investments with high idiosyncratic risk when their firms are in distress and receive less monitoring from institutional holders as well as when the aggregate economy is in a bad state. Second, the strategically increased idiosyncratic volatility decreases equity betas, particularly in bad states when the market risk premium is high. The negative covariance between the equity beta and the market risk premium causes low and negative returns and alphas in firms with high idiosyncratic volatility. © 2020 INFORMS.

Original language	English
Pages (from-to)	2751-2772
Journal	Management Science
Volume	67
Issue number	5
Online published	17 Jul 2020
DOIs	https://doi.org/10.1287/mnsc.2020.3593
Publication status	Published - May 2021
Externally published	Yes

Research Keywords

Agency conflicts
Idiosyncratic volatility puzzle
Risk shifting

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title = "Strategic risk shifting and the idiosyncratic volatility puzzle: An empirical investigation",

abstract = "We find strong empirical support for the risk-shifting mechanism to account for the puzzling negative relation between idiosyncratic volatility and future stock returns. First, equity holders take on investments with high idiosyncratic risk when their firms are in distress and receive less monitoring from institutional holders as well as when the aggregate economy is in a bad state. Second, the strategically increased idiosyncratic volatility decreases equity betas, particularly in bad states when the market risk premium is high. The negative covariance between the equity beta and the market risk premium causes low and negative returns and alphas in firms with high idiosyncratic volatility. {\textcopyright} 2020 INFORMS.",

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author = "Zhiyao Chen and Strebulaev, {Ilya A.} and Yuhang Xing and Xiaoyan Zhang",

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doi = "10.1287/mnsc.2020.3593",

language = "English",

volume = "67",

pages = "2751--2772",

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T1 - Strategic risk shifting and the idiosyncratic volatility puzzle

T2 - An empirical investigation

AU - Chen, Zhiyao

AU - Strebulaev, Ilya A.

AU - Xing, Yuhang

AU - Zhang, Xiaoyan

PY - 2021/5

Y1 - 2021/5

N2 - We find strong empirical support for the risk-shifting mechanism to account for the puzzling negative relation between idiosyncratic volatility and future stock returns. First, equity holders take on investments with high idiosyncratic risk when their firms are in distress and receive less monitoring from institutional holders as well as when the aggregate economy is in a bad state. Second, the strategically increased idiosyncratic volatility decreases equity betas, particularly in bad states when the market risk premium is high. The negative covariance between the equity beta and the market risk premium causes low and negative returns and alphas in firms with high idiosyncratic volatility. © 2020 INFORMS.

AB - We find strong empirical support for the risk-shifting mechanism to account for the puzzling negative relation between idiosyncratic volatility and future stock returns. First, equity holders take on investments with high idiosyncratic risk when their firms are in distress and receive less monitoring from institutional holders as well as when the aggregate economy is in a bad state. Second, the strategically increased idiosyncratic volatility decreases equity betas, particularly in bad states when the market risk premium is high. The negative covariance between the equity beta and the market risk premium causes low and negative returns and alphas in firms with high idiosyncratic volatility. © 2020 INFORMS.

KW - Agency conflicts

KW - Idiosyncratic volatility puzzle

KW - Risk shifting

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U2 - 10.1287/mnsc.2020.3593

DO - 10.1287/mnsc.2020.3593

M3 - RGC 21 - Publication in refereed journal

SN - 0025-1909

VL - 67

SP - 2751

EP - 2772

JO - Management Science

JF - Management Science

IS - 5

ER -

Strategic risk shifting and the idiosyncratic volatility puzzle: An empirical investigation

Abstract

Research Keywords

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