Doina C. Chichernea

Idiosyncratic Volatility, Institutional Ownership, and Investment Horizon

This paper reevaluates the cross-sectional effect of institutional ownership on idiosyncratic volatility by conditioning on institutions’ investment horizon. Prior literature establishes a positive link between growing institutional ownership and idiosyncratic volatility. However, this effect may vary depending on the type of institutional ownership. We document that short-term (long-term) institutional ownership is positively (negatively) linked to idiosyncratic volatility in the cross section. These opposite effects persist after controlling for institutional preferences and information-based trading and remain qualitatively unchanged after controlling for endogeneity. This suggests that short-term (long-term) institutions exhibit higher (lower) trading activity, which increases (decreases) idiosyncratic volatility.

Connecting the dots: the accruals quality premium vs the value premium

Two separate strands in the existing literature document that (1) the value premium may be the reward for risk generated by disagreement between investors with heterogeneous beliefs about future stock payoffs (Doukas et. al. 2002, 2004), and that (2) poor quality of accounting information is an important determinant of such disagreement (Lobo et. al. 2006). We investigate the connection between the accrual quality and the growth/value characteristics at firm level and whether there is any connection between the value premium and the accrual quality premium. This study provides evidence that value stocks are more likely to have high accrual quality, while growth stocks are more likely to have poor quality accruals. While the two premia are strongly connected during down markets, accrual quality does not seem to be the source that generates the higher dispersion of beliefs that value firms are documented to have. On the contrary, our results imply that value firms mitigate the quality of their information environment by providing better quality accounting information relative to growth firms.

Why is Accounting Information Important to Bondholders

The authors investigate the relevance of accounting information for bondholders. Their results imply that credit markets access firms’ default information through accounting signals. This information is reflected through cash flow (CF) and discount rate (DR) news. Specifically, the sensitivity of bond prices to news increases as firms get closer to default, owing to increasing firm-level credit risk or because aggregate credit conditions worsen. However, the latter is more important. Thus, the importance of a given accounting signal depends on 1) the mix of CF and DR news it reflects; 2) the firm’s proximity to default; and 3) the aggregate credit conditions. The authors incorporate these insights into a dynamic trading strategy that earns significant risk-adjusted returns. These results are robust after controlling for liquidity and transaction costs.

Is Idiosyncratic Risk a Source of Momentum

Recent studies reject the notion that momentum profits are compensation for risk by showing that momentum profits are mostly comprised of idiosyncratic components that cannot be risk (which, according to standard theory, must entail non-diversifiable systematic variation). Recent theoretical papers, however, show that idiosyncratic components of returns (in particular idiosyncratic risk) may affect risk premia. Using EGARCH-M, this paper estimates idiosyncratic risk and idiosyncratic risk premia at the individual security level and shows that idiosyncratic risk premia are responsible for between 70 and 90 percent of momentum profits. A closer examination shows that, although securities in the loser portfolio have higher levels of idiosyncratic risk than those in the winner portfolio (confirming other studies), the idiosyncratic risk premia in the loser portfolio are significantly less than those in the winner portfolio. Further supporting a link between idiosyncratic risk premia and momentum profits, we show that momentum portfolios formed by sorting on past idiosyncratic risk premia (rather than raw returns) generate significantly positive profits.