Expected Return-Idiosyncratic Risk Relation: An Investigation with Alternative Factor Models

32 Pages Posted: 7 Aug 2009 Last revised: 25 Feb 2010

See all articles by Carla M. Bainbridge

Carla M. Bainbridge

Monash University

Don U. A. Galagedera

Monash University - Department of Econometrics and Business Statistics

Date Written: August 7, 2009

Abstract

In this paper we investigate the relation between idiosyncratic risk and expected return by estimating idiosyncratic volatility in different factor models including the downside and upside market models. In the analysis with portfolios, our results suggest an inverse relation between idiosyncratic risk and expected return and that the relation may be non-linear. Our results are found to be affected by the global financial crisis with averages found to be higher when the main year of the crisis is excluded. We find that the relation between idiosyncratic volatility and expected return is robust to the factor model used in estimating idiosyncratic risk. This may be due to the very strong correlation between idiosyncratic risk of stocks estimated in different factor models.

Keywords: Idiosyncratic volatility, expected return, cross-sectional analysis

JEL Classification: G12, G15

Suggested Citation

Bainbridge, Carla M. and Galagedera, Don (Tissa) U. A., Expected Return-Idiosyncratic Risk Relation: An Investigation with Alternative Factor Models (August 7, 2009). 22nd Australasian Finance and Banking Conference 2009, Available at SSRN: https://ssrn.com/abstract=1445199 or http://dx.doi.org/10.2139/ssrn.1445199

Carla M. Bainbridge (Contact Author)

Monash University ( email )

Wellington Road
Clayton, Victoria 3168
Australia

Don (Tissa) U. A. Galagedera

Monash University - Department of Econometrics and Business Statistics ( email )

900 Dandenong Road
Caulfield East, VIC 3145
Australia
+61 3 9903 1578 (Phone)
+61 3 9903 2007 (Fax)

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