Idiosyncratic Volatility and Stock Returns: A Cross Country Analysis
San Diego State University - College of Business Administration
Massey University - Department of Economics and Finance
January 12, 2009
Applied Financial Economics, Forthcoming
Empirical evidences regarding the association of idiosyncratic volatility and stock returns are inconsistent with the capital asset pricing model (CAPM) which implies that idiosyncratic risk should not be priced because it would be fully eliminated through diversification. Using estimated-EGARCH conditional idiosyncratic volatility of individual stocks across 36 countries from 1973 to 2007, we find that idiosyncratic risk is priced on a significantly positive risk premium for stock returns. The evidence is statistically and economically significant. It overwhelmingly supports the prediction of existing theories that idiosyncratic risk is positively related to expected returns.
Keywords: Idiosyncratic risk, CAPM, Stock returns
JEL Classification: G12, G15Accepted Paper Series
Date posted: January 20, 2009
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