The role of idiosyncratic jumps in stock markets

Abstract

I study how realized idiosyncratic jumps play a role in pricing individual stocks. I find that stocks with high variances associated with positive idiosyncratic jumps tend to have low subsequent returns. To explain the negative premium, I show that positive idiosyncratic jump variances are important predictors for future skewness. Thus, my finding is consistent with investors’ preference for unusually large gains over short horizons. I demonstrate the economic significance of my results by highlighting the superior performance of a strategy based on variances associated with positive idiosyncratic jumps compared to strategies based on other variance measures.