Individual Stock Returns Volatility and Equity Anomalies

We examine the explanatory power of stock return volatility on well-documented equity anomalies. We estimate the time-varying volatility of stock returns using the EGARCH model. Using the estimated stock return volatility, we first form a volatility factor and incorporate it into a wide range of asset pricing models. Second, we adjust the loadings of risk factors in these asset pricing models. We then assess the impact of these two volatility-associated model modifications in mitigating equity anomalies. Our findings indicate that the volatility modifications enhance the explanatory power of asset pricing models and can provide more parsimonious models. Notably, momentum effects are reduced when the volatility factor is applied. Additionally, size and value anomalies are significantly diminished when the volatility factor is included and the factor loadings are adjusted for volatility. Our results are robust across two sub-sample periods of the past 20 years and during economic recessions.