Unusual News Flow and the Cross Section of Stock Returns

We document that stocks that experience sudden increases in idiosyncratic volatility underperform otherwise similar stocks in the future, and we propose that this phenomenon can be explained by the Miller conjecture [Miller E (1977) Risk, uncertainty, and divergence of opinion. J. Finance 32(4): 1151-1168]. We show that volatility shocks can be traced to unusual firm-level news flow, which temporarily increases the level of investor disagreement about the firm value. At the same time, volatility shocks pose a barrier to short selling, preventing pessimistic investors from expressing their views. In the presence of divergent opinions and short-selling constraints, prices initially reflect optimistic views but adjust downward in the future as investors' opinions converge.