Idiosyncratic Risk Matters!

43 Pages Posted: 17 Oct 2002  

Amit Goyal

University of Lausanne; Swiss Finance Institute

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2002

Abstract

This paper takes a new look at the predictability of stock market returns with risk measures. We find a significant positive relation between average stock variance (largely idiosyncratic) and the return on the market. In contrast,the variance of the market has no forecasting power for the market return. These relations persist after we control for macroeconomic variables known to forecast the stock market. The evidence is consistent with models of time-varying risk premia based on background risk and investor heterogeneity. Alternatively, our findings can be justified by the option value of equity in the capital structure of the firms.

Suggested Citation

Goyal, Amit and Santa-Clara, Pedro, Idiosyncratic Risk Matters! (July 2002). AFA 2003 Washington, DC Meetings. Available at SSRN: https://ssrn.com/abstract=331921 or http://dx.doi.org/10.2139/ssrn.331921

Amit Goyal (Contact Author)

University of Lausanne ( email )

Lausanne, Vaud CH-1015
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics ( email )

Lisbon
Portugal

HOME PAGE: http://docentes.fe.unl.pt/~psc/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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