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Idiosyncratic Volatility and the Pricing of Poorly-Diversified Portfolios

25 Pages Posted: 3 Jun 2011 Last revised: 10 Nov 2015

Joëlle Miffre

Audencia Nantes School of Management; Audencia Business School

Chris Brooks

University of Reading - ICMA Centre

Xiafei Li

Nottingham University Business School

Date Written: May 31, 2011

Abstract

This article examines the role of idiosyncratic volatility in explaining the cross-sectional variation of size- and value-sorted portfolio returns. We show that the premium for bearing idiosyncratic volatility varies inversely with the number of stocks included in the portfolios. This conclusion is robust within various multifactor models based on size, value, past performance, liquidity and total volatility and also holds within an ICAPM specification of the risk-return relationship. Our findings thus indicate that investors demand an additional return for bearing the idiosyncratic volatility of poorly-diversified portfolios.

Keywords: idiosyncratic risk, cross-sectional variation in stock returns, CAPM, conditional volatility, risk premium

JEL Classification: G12, G14

Suggested Citation

Miffre, Joëlle and Brooks, Chris and Li, Xiafei, Idiosyncratic Volatility and the Pricing of Poorly-Diversified Portfolios (May 31, 2011). International Review of Financial Analysis, Vol. 30, 2013. Available at SSRN: https://ssrn.com/abstract=1855944 or http://dx.doi.org/10.2139/ssrn.1855944

Joelle Miffre (Contact Author)

Audencia Nantes School of Management ( email )

8 route de la Jonelière, BP 31222
Nantes Cedex 3, Cedex 3 44312
France

Audencia Business School ( email )

8 Road Joneliere
BP 31222
Nantes Cedex 3, 44312
France

Chris Brooks

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom
+44 118 931 82 39 (Phone)
+44 118 931 47 41 (Fax)

Xiafei Li

Nottingham University Business School ( email )

Jubilee Campus
Nottingham, NG8 1BB
United Kingdom
+44 (0)115 9518603 (Phone)

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