Earnings Announcement Idiosyncratic Volatility and the Cross-Section of Stock Returns

Abstract

We document a significant positive relation between earnings announcement idiosyncratic volatility and stock returns in the 10-day window before future earnings announcements. The average of risk-adjusted return differences between stocks with the highest earnings announcement idiosyncratic volatility and stocks with the lowest earnings announcement idiosyncratic volatility exceeds 100 basis points in the 10 days leading up to the earnings announcements. The pricing of earnings announcement idiosyncratic volatility is asymmetric where only idiosyncratic volatility based on positive stock returns is priced. This is consistent with the argument that investors have a preference for stocks with large payoffs during earnings announcements.