Abstract This paper investigates the idiosyncratic volatility puzzle in China’s equity market. The empirical result shows that lagged idiosyncratic volatility is not a good estimate of expected idiosyncratic volatility and idiosyncratic volatility puzzle arises when researchers inappropriately use lagged volatilities as proxies for expected ones. This paper calculates expected idiosyncratic volatilities via ARMA models, and further tests the relationship between expected idiosyncratic volatilities and the expected returns. The result suggests that significant positive relationship exist between expected returns and expected idiosyncratic volatilities, even if various controlling variables are taken into consideration.
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Received: 14 October 2010
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