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RFS Advance Access published online on April 15, 2008
Review of Financial Studies, doi:10.1093/rfs/hhn039
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© The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org

Idiosyncratic Return Volatility, Cash Flows, and Product Market Competition

Paul J. Irvine
Terry College of Business, University of Georgia

Jeffrey Pontiff
Carroll School of Management, Boston College

Address correspondence to Paul Irvine, Terry College of Business, University of Georgia, Athens, GA. 30602, or e-mail: pirvine{at}uga.edu.

JEL Classification: G12, G14


  Abstract

Over the past 40 years, the volatility of the average stock return has drastically outpaced total market volatility. Thus, idiosyncratic return volatility has dramatically increased. We estimate this increase to be 6% per year. Consistent with an efficient market, this result is mirrored by an increase in the idiosyncratic volatility of fundamental cash flows. We argue that these findings are attributable to the more intense economy-wide competition. Various cross-sectional and time-series tests support this idea. Economic competitiveness facilitates reinterpretation of the results from the cross-country R2 literature, as well as the US idiosyncratic risk literature.

We thank Randy Becker, Pierluigi Balduzzi, Sam Choi, John Campbell, David Chapman, Wayne Ferson, Edie Hotchkiss, Jeffry Netter, Ed Rice, Matt Spiegel, Yexiao Xu, and seminar participants at Boston College, Cornell, Drexel, Georgia, Ohio State, UNLV, and the 2005 Western Finance Association Annual Meeting for helpful comments. We also thank Jim Linck for providing additional historical segment data, and Yong Chen, Ron Harris, Karthik Krishnan, and Ivonne Moya for research assistance.


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