Abstract

This thesis consists of three essays. The first essay (chapter two) examines the relationship between idiosyncratic volatility and future returns in the Canadian market. The negative relationship between realized idiosyncratic volatility (RIvol) and future returns uncovered by Ang et al. (2006) for the US market has been attributed to return reversals. For the Canadian market where return reversals have considerably less importance, we find that RIvol is positively related to future returns, even after controlling for risk loadings, illiquidity and reversals. Unlike the findings of Bali et al. (2011) for the US market, we find for the Canadian market that the relationship between extreme positive returns and future returns is positive and that idiosyncratic volatility is consistently positively related to future returns.
The second essay (chapter three) discusses the relationship between closed end fund discounts and the level of uncertainty about its holdings. Our trade-off model states that the intrinsic premium of a closed-end fund (CEF) is equal to the CEF’s price minus both its NAVPS (net asset value per share) and the net present value (NPV) of its future benefits from liquidity, managerial abilities and leverage minus its managerial costs. Any additional premium will persist to the extent that arbitrage between these two price series is both costly and risky. We find that arbitrage incompleteness due to the uncertainties about this NPV and the CEF’s holdings, as captured by idiosyncratic risk and other proxies, explains over two-thirds of the variation in CEF premiums or their changes. As expected, we find that the CEF premium is negatively related to gross leverage, management fees, cash and bond holdings, and positively related to liquidity enhancement, CEF performance and net leverage. These results are consistent with our finding that changes in CEF prices and NAVPS are more integrated than segmented using the Kappa test of Kapadia and Pu (2012).
The third essay (chapter four) investigates the information content of idiosyncratic volatility around the public release of M&A rumors. We examine the releases of hand-collected initial rumors about potential M&A for 2250 firms. Unlike previous research, we find that a strategy of investing in firms with rumors of lower (greater) credibility yields negative (positive) changes in idiosyncratic volatilities around the rumor dates and subsequent returns. We argue that this asymmetric effect on idiosyncratic volatilities is linked to asymmetric changes in the heterogeneity of the probabilities of actual M&A when conditioned on rumor credibility. Changes in idiosyncratic volatilities are positively related to the market implicit probabilities of M&A as measured by the ratio of the market values at the M&A announcement and rumor dates.