A Tale of Two Risks: The Role of Time in the Decomposition of Total Risk into Systematic and Idiosyncratic risks

45 Pages Posted: 10 Nov 2023

See all articles by Anthony Sanford

Anthony Sanford

HEC Montreal - Department of Finance

Yue Ma

Analysis Group, Inc. - New York City Office

Date Written: November 9, 2023

Abstract

Characterizing risk in financial markets has, at times, presented contradictory findings due to differing volatility estimation methodologies. Our research shows that the choice of time intervals in the volatility calculations distinctly captures different aspects of risk, depending on the stock's specific mean-reversion process. Short-interval volatilities predominantly capture idiosyncratic risk, while longer intervals capture systematic risk. This distinction, driven in part by characteristics like mean-reversion rates of the volatility processes, provides deeper insights into the conceptualizations of risk in the asset pricing literature. These findings are vital in categorizing retail traders as noise or informed based on risk.

Keywords: idiosyncratic risk, systematic risk, total risk, retail investors, high frequency trading

JEL Classification: G11, G12, G14, C18, C58

Suggested Citation

Sanford, Anthony and Ma, Yue, A Tale of Two Risks: The Role of Time in the Decomposition of Total Risk into Systematic and Idiosyncratic risks (November 9, 2023). Available at SSRN: https://ssrn.com/abstract=4600474 or http://dx.doi.org/10.2139/ssrn.4600474

Anthony Sanford (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Yue Ma

Analysis Group, Inc. - New York City Office ( email )

151 West 42 Street
23rd Floor
New York, NY 10036
United States

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