Idiosyncratic Volatility and the Intertemporal Capital Asset Pricing Model

54 Pages Posted: 17 Nov 2019 Last revised: 21 Nov 2021

See all articles by Bing Han

Bing Han

University of Toronto, Rotman School of Management

Gang Li

The Chinese University of Hong Kong, CUHK Business School

Date Written: October 30, 2019

Abstract

We show that the average stock return idiosyncratic volatility contains useful information about the covariance between the market and hedge portfolio under the ICAPM. Two different weighted averages of individual stock idiosyncratic volatility together can significantly predict stock market returns over both short- and long-term horizons, both in sample and out of sample. We propose a new method to estimate individual stock exposure to the unobserved hedge portfolio using aggregate idiosyncratic risk measures and find that the estimated beta is significantly related to the cross-section of expected stock returns. Finally, we show both theoretically and empirically that the return predictability of the tail index in Kelly and Jiang (2014) can be explained under the ICAPM. Our results support the ICAPM pricing relationship both in the time series and cross-section of stock returns.

Keywords: idiosyncratic volatility, conditional covariance, stock return predictability, intertemporal capital asset pricing model, tail risk

JEL Classification: G12, G13, G14, G17

Suggested Citation

Han, Bing and Li, Gang, Idiosyncratic Volatility and the Intertemporal Capital Asset Pricing Model (October 30, 2019). Available at SSRN: https://ssrn.com/abstract=3475179 or http://dx.doi.org/10.2139/ssrn.3475179

Bing Han

University of Toronto, Rotman School of Management ( email )

Toronto, Ontario M5S 3E6
Canada
4169460732 (Phone)

Gang Li (Contact Author)

The Chinese University of Hong Kong, CUHK Business School ( email )

Cheng Yu Tung Building, 12 Chak Cheung Street
Shatin
Hong Kong

HOME PAGE: http://sites.google.com/view/ganglihk

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