QRFE Seminar by Florian Weigert (University of Neuchâtel)

Hedge Funds and the Positive Idiosyncratic Volatility Effect

Abstract

While it is established that idiosyncratic volatility has a negative impact on the cross-section of stock returns, this relation is largely unexplored for hedge funds. We document that hedge funds with high idiosyncratic volatility earn higher future risk-adjusted returns of 6% p.a. than hedge funds with low idiosyncratic volatility. The outperformance arises because hedge funds trade high idiosyncratic volatility stocks wisely. They pick high volatility stocks when they are underpriced and short-sell high volatility stocks when they are overpriced. Our results support the notion that hedge funds’ idiosyncratic volatility is a measure of managerial skill.

About Prof Florian Weigert

Florian Weigert is Professor of Financial Risk Management at the University of Neuchâtel. His research focuses on empirical asset pricing, hedge funds, mutual funds, behavioral finance, and risk management. His research projects investigate, among others, the determinants of the cross-section of stock returns, performance measurement for hedge- and mutual funds, and the impact of investors’ behavioral biases. His work has been presented at leading academic conferences (such as the AFA, EFA, and FIRS meetings) and published in top finance journals (such as the Journal of Financial Economics, the Review of Finance, and the Journal of Financial & Quantitative Analysis).