Do Idiosyncratic Jumps Matter?

Abstract

We show that idiosyncratic jumps are a key determinant of mean stock returns from both an ex post and ex ante perspective. Ex post, the entire annual average return of a typical stock accrues on the four days on which its stock price jumps. Ex ante, idiosyncratic jump risk earns a premium: a value-weighted weekly long-short portfolio that buys stocks with high predicted jump probabilities earns annualized mean returns (four-factor alphas) of 9.4% (8.1%). This strategy's returns are larger when there are greater limits to arbitrage. These results are consistent with investor aversion to idiosyncratic jump risk.

Keywords: Idiosyncratic Jumps, Risk Premiums, Cross Section of Stock Returns

JEL Classification: G10, G11, G12, G13, G!4