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A Time-Varying Premium for Idiosyncratic Risk: Its Effects on the Cross-Section of Stock Returns

Abstract Merton (1987) predicts that idiosyncratic risk can be priced. I develop a simple equilibrium model of capital markets with information costs in which the idiosyncratic risk premium depends on the average level of idiosyncratic volatility. This dependence suggests that the idiosyncratic risk premium varies over time. I find that in U.S. markets, the covariance between stock-level idiosyncratic volatility and the idiosyncratic risk premium explains future stock returns. Stocks in the highest quintile of the covariance between the volatility and risk premium earn an average 3-factor alpha of 70 bps per month higher than those in the lowest quintile.
Created Date 2015
Contributor Xie, Daruo (Author) / Wahal, Sunil (Advisor) / Mehra, Rajnish (Advisor) / Arizona State University (Publisher)
Subject Finance
Type Doctoral Dissertation
Extent 65 pages
Language English
Reuse Permissions All Rights Reserved
Note Doctoral Dissertation Business Administration 2015
Collaborating Institutions Graduate College / ASU Library
Additional Formats MODS / OAI Dublin Core / RIS

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Description Dissertation/Thesis