Expected Profitability, the 52-Week High and the Idiosyncratic Volatility Puzzle

Abstract

We investigate the joint ability of fundamental-based and market-based news to explain the anomalous underperformance of stocks with high idiosyncratic volatility (high IVOL). An out-of-sample prediction of future profitability is adopted as a proxy for fundamental–based news while market-based news is represented by the 52-week high price ratio. A sample of UK stocks over the period January 1996 to December 2017 is analysed. The empirical results indicate that both the fundamental-based projected profitability and the 52-week high price ratio are important in explaining the IVOL anomaly. In contrast, individually, neither variable fully accounts for the anomaly. This relation is more pronounced following a period of high sentiment and during an upmarket. Further results suggest that underreaction lies at the heart of this explanation.