Idiosyncratic Volatility, Fundamentals, and Institutional Herding: Evidence from the Japanese Stock Market

We offer evidence that variations in firm idiosyncratic volatility are related to both behavior and fundamental factors. Using Japanese data from 1975 to 1999, we document that both institutional herding and the absolute value of firm earnings are positively related to idiosyncratic volatility. We find that institutional herding explains about 10% of the cross-sectional variation in idiosyncratic volatility, more than firm earnings, which account for less than 1%. Moreover, we reject the hypothesis that institutional investors herd toward stocks with high idiosyncratic volatility and systematic risk. We present preliminary results on the co-movement of dispersions of change in institutional ownership and return-on-asset with the market aggregate idiosyncratic volatility in the Japanese market. Our results, when relating to evidence on the U.S. market, suggest both investor behaviors and stock fundamentals may help explain the time-series pattern of market aggregate idiosyncratic volatility.