Have European Stocks Become More Volatile
32 Pages Posted: 12 Mar 2005
Date Written: February 25, 2005
We examine the dynamics of idiosyncratic risk, market risk and return correlations in European equity markets using weekly observations from 3515 stocks listed in the Euro-area stock markets in 12 countries over the period 1974-2004. Similarly to Campbell, Lettau, Malkiel and Xu (2001), we find an increase in idiosyncratic volatility, implying that it now takes more stocks to diversify away idiosyncratic risk. Contrary to their findings, however, market risk is trended upwards and correlations are trended mildly downwards. Market volatility leads the other volatility measures. Both the volatility and correlation measures are pro-cyclical, rising during times of low market returns, implying a skewed market portfolio return distribution. Market and average idiosyncratic volatility together predict market wide returns.
Keywords: Correlation dynamics, idiosyncratic risk, asset pricing, portfolio management
JEL Classification: C32, G11, G12, G12, G15
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