The Relationship Between Idiosyncratic Volatility and Portfolio Return within Swedish Stock Markets.

Abstract: Main results suggest there is a statistically and economically significant positive relationship between idiosyncratic volatility and portfolio return within the Swedish stock markets. This relationship is detected despite the low idiosyncratic volatility climate of Sweden. This is surprisingly true in the case of applying the methodology of Ang, Hodrick, Xing, and Zhang (2006), where a negative relationship was expected and not found. This is also true in the case of applying the exponential GARCH methodology of Fu (2009), where a positive relationship was expected and found, consistent with traditional theory. The key difference between the methods—ignoring the time-varying property of idiosyncratic volatility—leads to an overestimation of portfolio return. We demonstrate that the main results are sensitive to weighting-scheme, market specification, and chosen asset pricing model.