Is Idiosyncratic Risk Priced? The International Evidence

51 Pages Posted: 21 Mar 2009 Last revised: 5 Nov 2012

See all articles by Paul Brockman

Paul Brockman

Lehigh University - College of Business

Maria G. Vivero

The University of Dayton

Wayne Yu

City University of Hong Kong

Date Written: July 11, 2009

Abstract

We examine the relation between expected returns and idiosyncratic risk across 44 countries from 1980 to 2007. Theory suggests that expected returns are unrelated to idiosyncratic risk if investors hold fully-diversified portfolios, and positively related if investors hold under-diversified portfolios. The empirical evidence to date has been decidedly mixed. In this study, we apply Fu’s (2009) EGARCH model to an international setting and provide supportive evidence for a positive and significant relation between expected returns and idiosyncratic risk – suggesting that the typical investor holds an under-diversified portfolio. Our international dataset also allows us to examine the relation between country-level determinants of investor under diversification and idiosyncratic risk premiums. We find that such risk premiums are larger in markets with lower investor wealth and higher investor risk tolerance. We also find that investor characteristics are more important determinants of the size of the idiosyncratic risk premium than are information and transaction costs. Our study makes two primary contributions. First, we verify the existence of a positive risk premium for idiosyncratic volatility using over seven million observations from 58,000 stocks across 44 markets. Second, and perhaps more important, we show that idiosyncratic risk premiums are directly attributable to investor under-diversification.

Keywords: Idiosyncratic risk, Expected returns, Pricing, International markets

JEL Classification: G12, G15

Suggested Citation

Brockman, Paul and Vivero, Maria Gabriela and Yu, Wayne, Is Idiosyncratic Risk Priced? The International Evidence (July 11, 2009). Available at SSRN: https://ssrn.com/abstract=1364530 or http://dx.doi.org/10.2139/ssrn.1364530

Paul Brockman

Lehigh University - College of Business ( email )

Bethlehem, PA 18015
United States

Maria Gabriela Vivero (Contact Author)

The University of Dayton ( email )

300 College Park
Dayton, OH 45469
United States
937-229-3458 (Phone)

Wayne Yu

City University of Hong Kong ( email )

Kowloon
Hong Kong

Register to save articles to
your library

Register

Paper statistics

Downloads
724
Abstract Views
2,679
rank
34,480
PlumX Metrics