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The Value of Investor Sophistication

Chengbo Fu et al.

Financial Management2025https://doi.org/10.1111/fima.12497article
AJG 3ABDC A*
Weight
0.53

Abstract

We introduce the idiosyncratic volatility spread as a novel measure of the stock‐level investor sophistication. Our study reveals a negative relation between investor sophistication and stock returns, particularly for stocks with more binding short‐sale constraints. Importantly, this negative relation cannot be attributed to variables that affect the idiosyncratic volatility–return relation. Our findings hold across different factor models and estimation methods, demonstrating the robustness of the results. Furthermore, we observe that this relation is more pronounced during periods characterized by high investor sentiment, high market uncertainty, and economic contractions. Further tests suggest that investor sophistication introduces heterogeneity in beliefs among investors due to their varying model selection, demonstrating that investor sophistication is not driven solely by disagreement.

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https://doi.org/https://doi.org/10.1111/fima.12497

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@article{chengbo2025,
  title        = {{The Value of Investor Sophistication}},
  author       = {Chengbo Fu et al.},
  journal      = {Financial Management},
  year         = {2025},
  doi          = {https://doi.org/https://doi.org/10.1111/fima.12497},
}

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The Value of Investor Sophistication

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Evidence weight

0.53

Balanced mode · F 0.40 / M 0.15 / V 0.05 / R 0.40

F · citation impact0.50 × 0.4 = 0.20
M · momentum0.70 × 0.15 = 0.10
V · venue signal0.50 × 0.05 = 0.03
R · text relevance †0.50 × 0.4 = 0.20

† Text relevance is estimated at 0.50 on the detail page — for your query’s actual relevance score, open this paper from a search result.