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On the Relation between EGARCH Idiosyncratic Volatility and Expected Stock Returns

Published online by Cambridge University Press:  30 January 2014

Hui Guo ,
Haimanot Kassa  and
Michael F. Ferguson
Hui Guo
Affiliation:
hui.guo@uc.edu, Lindner College of Business, University of Cincinnati, PO Box 210195, Cincinnati, OH 45221
Haimanot Kassa
Affiliation:
kassah@miamioh.edu, Farmer School of Business, Miami University, 800 E High St, Oxford, OH 45056.
Michael F. Ferguson
Affiliation:
michael.ferguson@uc.edu, Lindner College of Business, University of Cincinnati, PO Box 210195, Cincinnati, OH 45221
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Abstract

A spurious positive relation between exponential generalized autoregressive conditional heteroskedasticity (EGARCH) estimates of expected month t idiosyncratic volatility and month t stock returns arises when the month t return is included in estimation of model parameters. We illustrate via simulations that this look-ahead bias is problematic for empirically observed degrees of stock return skewness and typical monthly return time series lengths. Moreover, the empirical idiosyncratic risk-return relation becomes negligible when expected month t idiosyncratic volatility is estimated using returns only up to month t − 1.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 49 , Issue 1 , February 2014 , pp. 271 - 296
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2014 

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