Why Does Idiosyncratic Risk Increase with Market Risk?

Söhnke Bartram, Gregory Brown and René Stulz

No 6560, CESifo Working Paper Series from CESifo

Abstract: From 1963 through 2015, idiosyncratic risk (IR) is high when market risk (MR) is high. We show that the positive relation between IR and MR is highly stable through time and is robust across exchanges, firm size, liquidity, and market-to-book groupings. Though stock liquidity affects the strength of the relation, it is strong for the most liquid stocks. The relation has roots in fundamentals. Higher market risk predicts greater idiosyncratic earnings volatility as well as dispersion and errors in analysts’ earnings forecasts. Firm characteristics related to the ability of firms to adjust to higher uncertainty help explain the strength of the relation. We find evidence that the relation is weaker for firms with more growth options, which is con-sistent with the view that such options provide a hedge against macroeconomic uncertainty.

Keywords: uncertainty; idiosyncratic risk; market risk; growth options; liquidity; limits to arbitrage (search for similar items in EconPapers)
JEL-codes: G10 G11 G12 (search for similar items in EconPapers)
Date: 2017
New Economics Papers: this item is included in nep-bec and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Why Does Idiosyncratic Risk Increase with Market Risk? (2016)
Working Paper: Why Does Idiosyncratic Risk Increase with Market Risk? (2016)
Working Paper: Why does idiosyncratic risk increase with market risk? (2016)
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