Forthcoming, International Review of Financial Analysis.
20 Pages Posted: 18 Feb 2014 Last revised: 23 Dec 2014
Date Written: September 2014
We test whether firm idiosyncratic risk is priced in a large cross-section of U.K. stocks. A distinguishing feature of our paper is that our tests allow for a conditional relationship between systematic risk (beta) and returns in our tests, i.e., conditional on whether the excess market return is positive or negative. We find strong evidence in support of a conditional beta/return relationship which in turn reveals conditionality in the pricing of idiosyncratic risk. We find that idiosyncratic risk is significantly negatively priced in stock returns in down-markets. Although perhaps initially counter-intuitive, we describe the theoretical support for such a finding in the literature. Our results also reveal a strong role for liquidity, size and momentum factors in explaining the cross-section of U.K. stock returns.
Keywords: G11; G12.
JEL Classification: asset pricing; idiosyncratic risk; turnover; conditional beta.
Suggested Citation: Suggested Citation
Cotter, John and O'Sullivan, Niall and Rossi, Francesco, The Conditional Pricing of Systematic and Idiosyncratic Risk in the U.K. Equity Market (September 2014). Forthcoming, International Review of Financial Analysis.. Available at SSRN: https://ssrn.com/abstract=2397308 or http://dx.doi.org/10.2139/ssrn.2397308