Is Idiosyncratic Risk Conditionally Priced?

37 Pages Posted: 1 Mar 2016

See all articles by Rajnish Mehra

Rajnish Mehra

Arizona State University (ASU) - W.P Carey School of Business, Department of Economics; National Bureau of Economic Research (NBER)

Sunil Wahal

Arizona State University (ASU) - Finance Department

Daruo Xie

Australian National University (ANU)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2016

Abstract

In Merton (1987), idiosyncratic risk is priced in equilibrium as a consequence of incomplete diversification. We modify his model to allow the degree of diversification to vary with average idiosyncratic volatility. This simple recognition results in a state-dependent idiosyncratic risk premium that is higher when average idiosyncratic volatility is low, and vice versa. The data appear to be consistent with a positive state-dependent premium for idiosyncratic risk both in the US and in other developed markets.

Suggested Citation

Mehra, Rajnish and Wahal, Sunil and Xie, Daruo, Is Idiosyncratic Risk Conditionally Priced? (February 2016). NBER Working Paper No. w22016. Available at SSRN: https://ssrn.com/abstract=2739542

Rajnish Mehra (Contact Author)

Arizona State University (ASU) - W.P Carey School of Business, Department of Economics ( email )

Tempe, AZ 85287-3806
United States
480 965 6335 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Sunil Wahal

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

Daruo Xie

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

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