DP4812 Idiosyncratic Volatility and Product Market Competition

Author(s): José-Miguel Gaspar, Massimo Massa
Publication Date: December 2004
Keyword(s): competition, idiosyncratic volatility, market powers, uncertainty
JEL(s): G10, G12, L11
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4812

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.