Idiosyncratic volatility and nominal stock prices: evidence from approximate factor structures

Authors: Patrick ROGER, Tristan ROGER, Alain SCHATT

This paper examines the relationship between idiosyncratic volatility and nominal stock prices using an approximate factor structure model, contributing to the literature on asset pricing anomalies.

Abstract

The idiosyncratic volatility puzzle — the finding that stocks with high idiosyncratic volatility tend to earn lower future returns — has been one of the most debated anomalies in the asset pricing literature. This paper revisits this puzzle by examining its interaction with nominal stock prices.

Using an approximate factor structure approach, we disentangle systematic and idiosyncratic components of return variation and examine whether the relationship between idiosyncratic risk and expected returns is uniform across the price spectrum. Our analysis covers a broad cross-section of stocks traded on major European exchanges.

Findings

We find that the idiosyncratic volatility puzzle is concentrated among low-priced stocks, consistent with the hypothesis that nominal price levels proxy for investor sophistication and trading cost effects. The approximate factor structure approach allows us to control for common risk factors more flexibly than traditional methods.