Heterogeneous beliefs and idiosyncratic volatility puzzle: evidence from China
China Finance Review International
ISSN: 2044-1398
Article publication date: 6 August 2020
Issue publication date: 26 January 2021
Abstract
Purpose
The purpose of our study is to explore the “idiosyncratic volatility puzzle” in Chinese stock market from the perspective of investors' heterogeneous beliefs. To delve into the relationship between idiosyncratic volatility and investors' heterogeneous beliefs, and uncover the ability of heterogeneous beliefs, as well as to explain the “idiosyncratic volatility puzzle”, we construct our study as follows.
Design/methodology/approach
Our study adopts the unexpected trading volume as proxies of heterogeneity, the residual of Fama–French three-factor model as proxies of idiosyncratic volatility. Portfolio strategies and Fama–MacBeth regression are used to investigate the relationship between the two proxies and stock returns in Chinese A-share market.
Findings
Investors' heterogeneous beliefs, as an intermediary variable, are positively correlated with idiosyncratic volatility. Meanwhile, it could better demonstrate the negative correlation between the idiosyncratic volatility and future stock returns. It is one of the economic mechanisms linking idiosyncratic volatility to subsequent stock returns, which can account for 11.28% of the puzzle.
Originality/value
The findings indicate that idiosyncratic volatility is significantly and positively correlated with heterogeneous beliefs and that heterogeneous beliefs are effective intervening variables to explain the “idiosyncratic volatility puzzle”.
Keywords
Acknowledgements
This work was supported by the National Nature Science Foundation of China [grant number 71473206, 71773100, 91746109] and we sincerely thank the two anonymous reviewers for their comments and suggestions.
Citation
He, M., Huang, J. and Zhu, H. (2021), "Heterogeneous beliefs and idiosyncratic volatility puzzle: evidence from China", China Finance Review International, Vol. 11 No. 1, pp. 124-141. https://doi.org/10.1108/CFRI-07-2019-0128
Publisher
:Emerald Publishing Limited
Copyright © 2020, Emerald Publishing Limited