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Idiosyncratic Volatility: Evidence from Asia: Discussion Paper No. 107

Drew, Michael E. & Veeraraghavan, Madhu (2002) Idiosyncratic Volatility: Evidence from Asia: Discussion Paper No. 107. [Working Paper]

Abstract

The traditional Capital Asset Pricing Model states that assets can earn only higher returns if they have a high beta. However, evidence shows that the single risk factor is not quite adequate for describing the cross-section of stock returns. The current consensus is that firm size and book-to-market equity factors are pervasive risk factors besides the overall market factor. Malkiel and Xu (1997 and 2000) further the debate in empirical asset pricing by stating that idiosyncratic volatility is useful in explaining the cross-sectional expected returns. In this paper we provide international evidence on the relationship between expected stock returns, overall market factor, firm size and idiosyncratic volatility. Our findings suggest that size and idiosyncratic volatility premium are real and pervasive. We find that small and high idiosyncratic volatility stocks generate superior returns and hence suggest that such firms carry risk premia. Our findings also suggest that idiosyncratic volatility is more powerful than the CAPM beta and the firm size effect. Our findings challenge the portfolio theory of Markowitz (1952) and the CAPM of Sharpe (1964), which advances the notion that it is rational for a utility maximizing investor to hold a well-diversified portfolio of investments to eliminate idiosyncratic risks

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ID Code: 529
Item Type: Working Paper
Additional URLs:
Keywords: Idiosyncratic risk, Portfolio Theory, Capital Asset Pricing Model, Size effect and Beta
ISSN: 1324-5910
Subjects: Australian and New Zealand Standard Research Classification > ECONOMICS (140000) > APPLIED ECONOMICS (140200) > Financial Economics (140207)
Divisions: Current > QUT Faculties and Divisions > QUT Business School
Copyright Owner: Copyright 2002 (Please consult author)
Deposited On: 09 Nov 2004
Last Modified: 02 Feb 2012 19:44

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