The Conditional Pricing of Systematic and Idiosyncratic Risk in the U.K. Equity Market
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