Time variation of MAX-premium with market volatility: Evidence from Korean stock market

Korean stock market provides an ideal setting to examine the time-variation of the premium for stocks with a large price jump (MAX) because the market is mostly dominated by individual investors who are more prone to behavioral bias than institutional investors are. We find that investors' overpayment for stocks with high MAX is driven by increased salience of such stocks especially in the period with high uncertainty, measured by high local market volatility. We further find evidence that the negative relation between stock returns and idiosyncratic volatility, which is much stronger for stocks with high MAX than for stocks with low MAX, is more pronounced in the period with high market volatility. Overall, our findings emphasize that when investors have limited attention, attention-grabbing features of high MAX drives the time-variation in the degree of overpayment for stocks with high MAX and helps explain the idiosyncratic volatility puzzle.