The purpose of our study is to explore the “idiosyncratic volatility puzzle” in Chinese stock market from the perspective of investors' heterogeneous beliefs. To delve into the relationship between idiosyncratic volatility and investors' heterogeneous beliefs, and uncover the ability of heterogeneous beliefs, as well as to explain the “idiosyncratic volatility puzzle”, we construct our study as follows.
Our study adopts the unexpected trading volume as proxies of heterogeneity, the residual of Fama–French three-factor model as proxies of idiosyncratic volatility. Portfolio strategies and Fama–MacBeth regression are used to investigate the relationship between the two proxies and stock returns in Chinese A-share market.
Investors' heterogeneous beliefs, as an intermediary variable, are positively correlated with idiosyncratic volatility. Meanwhile, it could better demonstrate the negative correlation between the idiosyncratic volatility and future stock returns. It is one of the economic mechanisms linking idiosyncratic volatility to subsequent stock returns, which can account for 11.28% of the puzzle.
The findings indicate that idiosyncratic volatility is significantly and positively correlated with heterogeneous beliefs and that heterogeneous beliefs are effective intervening variables to explain the “idiosyncratic volatility puzzle”.
