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The Long and Short of the Vol Anomaly

Last Updated on 10 February, 2024 by Rejaul Karim

In “The Long and Short of the Vol Anomaly,” Bradford D. Jordan and Timothy B. Riley delve into the intricate relationship between stock volatility, short interest, and market anomalies.

Spanning 97 pages, the research unveils a nuanced interplay where high volatility indicates both positive and negative future abnormal performance. A key revelation is that within high volatility stocks, those with low short interest yield extraordinary positive returns, while those with high short interest experience equally extraordinary negative returns.

This study not only explores the complex connection between volatility and short interest puzzles but also provides fresh insights into market efficiency and abnormal returns.

Abstract Of Paper

On average, stocks with high prior-period volatility underperform those with low prior-period volatility, but that simple comparison paints an incomplete, and potentially misleading, picture. As we show, high volatility is an indicator of both positive and negative future abnormal performance. Among high volatility stocks, those with low short interest experience extraordinary positive returns, while those with high short interest experience equally extraordinary negative returns. Our results show that there is a surprisingly strong connection between the volatility and short interest puzzles and that studying the two together yields new and sharper insights into both.

Original paper – Download PDF

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Author

Bradford D. Jordan
University of Florida; University of Florida – Department of Finance, Insurance and Real Estate

Timothy B. Riley
University of Arkansas – Department of Finance

Conclusion

In summary, the study unravels the nuanced relationship between volatility and abnormal stock performance, offering a more intricate understanding than the conventional view of high volatility leading to underperformance. Beyond a simplistic dichotomy, the research uncovers a dual nature within high-volatility stocks, with a crucial distinction based on short interest.

Remarkably, low short interest among high-volatility stocks signals exceptionally positive future returns, while high short interest points to equally exceptional negative returns. This novel perspective intertwines the volatility and short interest puzzles, enriching our comprehension of both phenomena.

By exploring these dimensions collectively, the study provides a more refined and insightful perspective on the intricate dynamics governing stock performance, challenging conventional wisdom and opening avenues for further exploration in market efficiency and abnormal returns.

Related Reading:

Trend Momentum II: Driving Forces of Low Volatility and Momentum

Stock Return Volatility, Operating Performance and Stock Returns: International Evidence on Drivers of the ‘Low Volatility’ Anomaly

FAQ

Q1: What is the main focus of the research paper?

A1: The research paper explores the relationship between stock volatility, short interest, and market anomalies. It specifically investigates how high volatility in stocks can indicate both positive and negative future abnormal performance.

Q2: What key revelation does the study make regarding high-volatility stocks?

A2: The study reveals that within high-volatility stocks, those with low short interest tend to yield extraordinary positive returns, while those with high short interest experience equally extraordinary negative returns. This finding adds a nuanced layer to understanding the performance of high-volatility stocks.

Q3: How does the research contribute to our understanding of market anomalies?

A3: The research contributes by intertwining the volatility and short interest puzzles, providing a more intricate understanding of abnormal stock performance. It challenges the conventional view that high volatility universally leads to underperformance, highlighting the importance of considering short interest in analyzing the dynamics of high-volatility stocks.

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