The idiosyncratic volatility puzzle and mergers and acquisitions activity

Article type: Research Article

Authors: Switzer, Lorne N.^{; *} | El Meslmani, Nabil

Affiliations: John Molson School of Business, Concordia University, Canada. Tel.: 1-(514) 848-2424 ext. 2960; E-mails: [email protected], [email protected]

Correspondence: [*] Corresponding author. Tel.: 1-(514) 848-2424 ext. 2960; E-mail: [email protected].

Abstract: This paper examines whether the puzzling negative relationship between idiosyncratic volatility and next month performance is affected by the intensity of merger and acquisition (M&A) activity in the market. Our results show that the idiosyncratic volatility puzzle is stronger in periods of high M&A activity than in periods of low M&A activity. Further analysis shows that the negative relationship between idiosyncratic volatility and next month performance is the strongest in the high M&A activity sub-period spanning from 1982–1989. In contrast, M&A activity does not explain the negative relationship between the common factor in idiosyncratic volatility (CIV) and next month performance. M&A activity can in part explain the idiosyncratic volatility puzzle, but it does not subsume the negative relationship between CIV exposure and firm returns.

Keywords: Idiosyncratic Volatility, mergers and acquisitions activity, merger and acquisition waves, volatility trends, expected returns, asset pricing, multifactor models

DOI: 10.3233/RDA-170127

Journal: Risk and Decision Analysis, vol. 6, no. 3, pp. 193-212, 2017