Is idiosyncratic risk conditionally priced?

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

In Merton (1987), idiosyncratic risk is priced in equilibrium as a consequence of incomplete diversification. We modify his model to allow the degree of diversification to vary with average idiosyncratic volatility. This simple recognition results in a state-dependent idiosyncratic risk premium that is higher when average idiosyncratic volatility is low, and vice versa. The data appear to be consistent a positive state-dependent premium for idiosyncratic risk both in the US and other developed markets.

Original languageEnglish (US)
Pages (from-to)625-646
Number of pages22
JournalQuantitative Economics
Volume12
Issue number2
DOIs
StatePublished - May 2021

Keywords

  • factor models
  • G11
  • G12
  • Idiosyncratic risk
  • risk premium asset pricing

ASJC Scopus subject areas

  • Economics and Econometrics

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