Explanations for the low volatility anomaly : an empirical analysis of the Norwegian stock market

Abstract

In this thesis, we examine the relation between idiosyncratic volatility and stock returns. Inspired by recent studies on the low volatility anomaly, we document the existence of and explain this phenomenon in the Norwegian stock market. We use a rolling window model to estimate idiosyncratic volatility, and find that stocks with low idiosyncratic volatility significantly outperform stocks with high idiosyncratic volatility in terms of Fama and French (1993) alphas. Next, we evaluate various potential explanations for the anomaly. Controlling for firm characteristics by performing a double sort, we show that firm size, skewness and illiquidity effects can explain the low returns of stocks with high idiosyncratic volatility. Our results also suggest short-term return reversals as an explanation of the low volatility anomaly. Further, we show that using a more sophisticated method to estimate idiosyncratic volatility provide no evidence of a low volatility anomaly.