Working Paper: CEPR ID: DP4812
Authors: Jos Miguel Gaspar; Massimo Massa
Abstract: This Paper investigates the link between a firm?s competitive environment and the idiosyncratic volatility of its stock returns. We find that firms enjoying high market power, or established in concentrated industries, have lower idiosyncratic volatility. We posit that competition affects volatility in two distinct and inter-related ways. Market power works as a hedging instrument that smoothes out idiosyncratic fluctuations. At the same time, a high degree of market power implies lower information uncertainty for investors and therefore lower return volatility. We find strong support for both effects. Our results contribute to the understanding of recent trends of idiosyncratic volatility, and confirm the important link between stock market performance and the competitive environment of firms.
Keywords: competition; idiosyncratic volatility; market powers; uncertainty
JEL Codes: G10; G12; L11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Market Power (L11) | Information Uncertainty (D80) |
| Information Uncertainty (D80) | Idiosyncratic Volatility (G19) |
| Competition (L13) | Profit Volatility (G17) |
| Profit Volatility (G17) | Idiosyncratic Volatility (G19) |
| Market Power (L11) | Idiosyncratic Volatility (G19) |
| Industry-Adjusted Price-Cost Margin (L11) | Idiosyncratic Volatility (G19) |