Expected Return-Idiosyncratic Risk Relation: An Investigation with Alternative Factor Models
32 Pages Posted: 7 Aug 2009 Last revised: 25 Feb 2010
Date Written: August 7, 2009
Abstract
In this paper we investigate the relation between idiosyncratic risk and expected return by estimating idiosyncratic volatility in different factor models including the downside and upside market models. In the analysis with portfolios, our results suggest an inverse relation between idiosyncratic risk and expected return and that the relation may be non-linear. Our results are found to be affected by the global financial crisis with averages found to be higher when the main year of the crisis is excluded. We find that the relation between idiosyncratic volatility and expected return is robust to the factor model used in estimating idiosyncratic risk. This may be due to the very strong correlation between idiosyncratic risk of stocks estimated in different factor models.
Keywords: Idiosyncratic volatility, expected return, cross-sectional analysis
JEL Classification: G12, G15
Suggested Citation: Suggested Citation
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