Price Momentum and Idiosyncratic Volatility

We show that stocks with higher idiosyncratic volatility display greater price momentum; a relation which is economically large, statistically significant, and robust. Stocks with higher idiosyncratic volatility also experience quicker and larger reversals. These findings are consistent with the view that momentum profits are attributable to underreaction to firm-specific information. Our findings are also consistent with the hypothesis that idiosyncratic volatility is an important factor in limiting the successful arbitrage of the momentum effect. Further, we find a positive time-series relation between momentum returns and aggregate idiosyncratic volatility. Given the long-term rise in idiosyncratic volatility, this result helps explain why momentum profits not only persist but also increase after the sample period examined by Jegadeesh and Titman (1993). This Draft: February 2005 * Arena, Haggard, and Yan are with the Department of Finance at the University of Missouri – Columbia. Yan is the corresponding author and may be contacted at 427 Cornell Hall, University of Missouri, Columbia, MO 65211. Tel: (573) 884-9708, Fax: (573) 884-6296, E-mail: [email protected]. We thank Paul Brockman, John Howe, Cyndi McDonald, Sandra Mortal, Doug Witte, and seminar participants at the University of Missouri – Columbia for valuable comments. We also benefit from a conversation with Richard Roll. We thank I/B/E/S for providing analyst coverage data.