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Why Does Idiosyncratic Risk Increase with Market Risk?

Charles A. Dice Center Working Paper No. 2016-13

Fisher College of Business Working Paper No. 2016-03-13

48 Pages Posted: 30 Jul 2016  

Söhnke M. Bartram

Warwick Business School - Department of Finance

Gregory W. Brown

University of North Carolina (UNC) at Chapel Hill - Finance Area

René M. Stulz

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 4 versions of this paper

Date Written: July 2016

Abstract

From 1963 through 2015, idiosyncratic risk (IR) is high when market risk (MR) is high. We show that the positive relation between IR and MR is highly stable through time and is robust across exchanges, firm size, liquidity, and market-to-book groupings. Though stock liquidity affects the strength of the relation, the relation is strong for the most liquid stocks. The relation has roots in fundamentals as higher market risk predicts greater idiosyncratic earnings volatility and as firm characteristics related to the ability of firms to adjust to higher uncertainty help explain the strength of the relation. Consistent with the view that growth options provide a hedge against macroeconomic uncertainty, we find evidence that the relation is weaker for firms with more growth options.

Keywords: Uncertainty, idiosyncratic risk, market risk, growth options, liquidity, limits to arbitrage

JEL Classification: G10, G11, G12

Suggested Citation

Bartram, Söhnke M. and Brown, Gregory W. and Stulz, René M., Why Does Idiosyncratic Risk Increase with Market Risk? (July 2016). Charles A. Dice Center Working Paper No. 2016-13; Fisher College of Business Working Paper No. 2016-03-13. Available at SSRN: https://ssrn.com/abstract=2816138 or http://dx.doi.org/10.2139/ssrn.2816138

Söhnke M. Bartram

Warwick Business School - Department of Finance ( email )

Coventry, CV4 7AL
United Kingdom
+44 (24) 7657 4168 (Phone)
+1 425 952 1070 (Fax)

HOME PAGE: http://go.warwick.ac.uk/sbartram/

Gregory W. Brown

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Rene M. Stulz (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

HOME PAGE: http://www.cob.ohio-state.edu/fin/faculty/stulz

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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