In this thesis, we examine the relation between idiosyncratic volatility and stock returns.
Inspired by recent studies on the low volatility anomaly, we document the existence of
and explain this phenomenon in the Norwegian stock market. We use a rolling window
model to estimate idiosyncratic volatility, and find that stocks with low idiosyncratic
volatility significantly outperform stocks with high idiosyncratic volatility in terms of
Fama and French (1993) alphas. Next, we evaluate various potential explanations for
the anomaly. Controlling for firm characteristics by performing a double sort, we show
that firm size, skewness and illiquidity effects can explain the low returns of stocks
with high idiosyncratic volatility. Our results also suggest short-term return reversals
as an explanation of the low volatility anomaly. Further, we show that using a more
sophisticated method to estimate idiosyncratic volatility provide no evidence of a low
volatility anomaly.nhhma