A Revisit on Idiosyncratic Volatility Puzzle: Evidence from Sri Lanka

Abstract

The inconclusive inferences on empirical findings on idiosyncratic volatility have created a substantive puzzle in the asset pricing literature.The purpose of this study is to analyze the long debated idiosyncratic volatility puzzle from a South Asian market point of view. Using 214 non-financial firms listed on the Colombo Stock Exchange over a period of 163 months from September 2004 to March 2018, this study documents that idiosyncratic volatility has a positive and statistically significant impact on average stock returns in Sri Lanka. Moreover, the empirical results confirm that idiosyncratic volatility is high with small stocks which are exposed to lower level of profits and investments. Thus, it is still questionable as to why there is a high demand for small stocks in the market. More importantly, the findings of current study on profitability and investment yield striking evidence on idiosyncratic volatility of stocks which is a marked departure from previous studies of its kind.