Juliana Malagon
Ph.D. Student, Universidad Carlos III, Spain.
David Moreno
Associate Professor, Universidad Carlos III, Spain.
Roja Rodriguez
Associate Professor, Universidad Carlos III, Spain.Time Horizon Trading and the Idiosyncratic
Risk Puzzle
We analyze if the idiosyncratic risk puzzle exposed on Ang et al.,
(2006, 2009) is the result of heterogeneous investors in the market
having different time horizons: short-term and long-term investors. We
adopt a Wavelet Multiresolution Analysis to decompose returns
distribution in different scales corresponding to different groups of
investors. The main conclusion of the paper is that the puzzle is the
result of short-term investors’ behavior. Also, the Wavelet Transform
divides the nonlinear relation between expected returns and
idiosyncratic risk into two linear relations: a positive relation for long-
term investors and a negative relation for short-term ones. This inverse
relation is challenging but might be attenuated by the fact that short-
term investors usually profit from an investing opportunity and do not
keep a position for a whole month.