Idiosyncratic Volatility and Earnings Quality: Evidence from United Kingdom

Ana Isabel Ramos Domingues (), António de Melo da Costa Cerqueira () and Elísio Fernando Moreira Brandão ()
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Ana Isabel Ramos Domingues: FEP-UP, School of Economics and Management, University of Porto
António de Melo da Costa Cerqueira: FEP-UP, School of Economics and Management, University of Porto
Elísio Fernando Moreira Brandão: FEP-UP, School of Economics and Management, University of Porto

FEP Working Papers from Universidade do Porto, Faculdade de Economia do Porto

Abstract: Recently, the idiosyncratic volatility has captured much of the attention of the financial literature, being the idiosyncratic volatility puzzle one of the most studied. Our study aims to verify if the financial reporting quality, proxied by earnings quality, an accrual-based measure, has an impact on idiosyncratic return volatility, using as sample the firms listed on London Stock Exchange, and comprising the period between 1988 and 2015. To account for the robustness of our results, we used several control variables, such as leverage, size, ratio book-to-market, firm age and firm performance. We conclude that earnings quality has a positive impact on idiosyncratic volatility, meaning that poorer information quality implies higher idiosyncratic volatility. Posteriorly, we extend our study to a trend analysis, asking if the earnings quality behaviour is related with the idiosyncratic volatility trends. We prove that idiosyncratic volatility does not have a constant upward trend, instead it behaves like ebbs and flows. We found that earnings quality has an impact, albeit small, in the overall trend of idiosyncratic volatility, and also explains its episodic behaviour.

Keywords: Idiosyncratic Volatility; Earnings Quality; Abnormal Accruals; Time Series Analysis (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 G32 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2016-10
New Economics Papers: this item is included in nep-bec, nep-cfn and nep-fmk
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