The Cross-Section of Volatility and Expected Returns

Robert Hodrick, Andrew Ang

Research

56 Pages

This paper examines how aggregate and firm specific volatility relate to expected stock returns. The authors find a roughly 1% annual negative price for aggregate volatility risk, while stocks with the highest idiosyncratic volatility earn strikingly lower returns even after controlling for common market effects.

Key Takeaways

Volatility Risk Is Priced: Innovations in aggregate volatility carry an estimated negative risk price of approximately 1% annually.
High Volatility Lags: The highest idiosyncratic volatility quintile underperformed the lowest by 1.06% per month in average returns.
Alpha Gap Persists: After Fama French adjustment, the highest volatility quintile trailed the lowest by 1.31% per month, with a t statistic of 7.00.
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