Idiosyncratic risk related asset pricing theory.

The Cross-Section of Volatility

and Expected Returns

ANDREW ANG, ROBERT J. HODRICK, YUHANG XING, and XIAOYAN ZHANG∗

ABSTRACT

We examine the pricing of aggregate volatility risk in the cross-section of stock returns.

Consistent with theory, we find that stocks with high sensitivities to innovations in

aggregate volatility have low average returns. Stocks with high idiosyncratic volatility

relative to the Fama and French (1993, Journal of Financial Economics 25, 2349)

model have abysmally low average returns. This phenomenon cannot be explained by

exposure to aggregate volatility risk. Size, book-to-market, momentum, and liquidity

effects cannot account for either the low average returns earned by stocks with high

exposure to systematic volatility risk or for the low average returns of stocks with

high idiosyncratic volatility.