Discussion Paper Details

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Title: Idiosyncratic Volatility and Product Market Competition

Author(s): Josť-Miguel Gaspar and Massimo Massa

Publication Date: December 2004

Keyword(s): competition, idiosyncratic volatility, market powers and uncertainty

Programme Area(s): Financial Economics

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.

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Bibliographic Reference

Gaspar, J and Massa, M. 2004. 'Idiosyncratic Volatility and Product Market Competition'. London, Centre for Economic Policy Research.