Ang et al. (2009): The Global Volatility Puzzle

#The Paper at a Glance

Title: High idiosyncratic volatility and low returns: International and further U.S. evidence

Authors: Andrew Ang, Robert J. Hodrick, Yuhang Xing, and Xiaoyan Zhang

Published: Journal of Financial Economics, 2009

DOI: 10.1016/j.jfineco.2008.03.003

In 2006, this team shocked the finance world by showing that high-volatility U.S. stocks had abysmally low returns. Critics argued it might be a data mining fluke.

So in 2009, they took the show on the road. They analyzed 23 developed markets from 1980 to 2003.

The Result: The anomaly was even stronger globally.

#The Findings

In every single G7 country (Canada, France, Germany, Italy, Japan, UK, US), the strategy of buying low-volatility stocks and selling high-volatility stocks generated positive alpha.

Global Spread: -1.31% per month (-15.7% annualized). This means high-volatility stocks destroyed wealth at a staggering rate.

What Is "Idiosyncratic" Volatility?

Total Volatility = Market Risk (Beta) + Idiosyncratic Risk (Stock-Specific Noise).

Even after controlling for Beta, Size, Book-to-Market, and Momentum, the negative relationship held. It wasn't just that these were small or growth stocks—it was the volatility itself that predicted failure.

#Why Do Investors Buy Losing Stocks?

The authors suggest a behavioral explanation: Preference for Skewness.

High-volatility stocks are like lottery tickets. Most lose money, but a few pay off 100x (like Amazon in 1999). Investors are willing to accept a negative expected return for the small chance of a massive jackpot.

Institutional investors (who should know better) are constrained by benchmarking (see Baker et al. 2011), preventing them from correcting the price.

#How This Applies to Our Rankings

This confirms our Low Volatility factor (10% weight).

We measure volatility over a trailing 60-day window. We reward stocks with stable price action and penalize those with erratic swings. This keeps "lottery tickets" out of our top rankings.

While lottery tickets are fun to buy, they are a terrible retirement strategy. We act as the "Casino House," systematically taking the other side of these bets.

See stable, low-volatility stocks →

#Academic Source

Ang, A., Hodrick, R. J., Xing, Y., & Zhang, X. (2009). "High idiosyncratic volatility and low returns: International and further U.S. evidence." Journal of Financial Economics, 91(1), 1-23.