Idiosyncratic Return Volatility, Cash Flows, and Product Market Competition

Abstract

Over the past forty years, the volatility of the average stock return has drastically outpaced total market volatility. Thus, idiosyncratic return volatility has dramatically increased. We estimate this increase to be 6% per year. Consistent with an efficient market, we show that this result is mirrored by an increase in the idiosyncratic volatility of fundamental cash flows. We argue that these findings are attributable to more intense economy-wide competition. Various cross-sectional and time-series tests support this idea. Economic competitiveness facilitates reinterpretation of the results from previous studies.