Can Asset Pricing Models Price Idiosyncratic Risk in U.K. Stock Returns?

Jonathan Fletcher

The Financial Review, 2007, vol. 42, issue 4, 507-535

Abstract: I examine how well different linear factor models and consumption‐based asset pricing models price idiosyncratic risk in U.K. stock returns. Correctly pricing idiosyncratic risk is a significant challenge for many of the models I consider. For some consumption‐based models, there is a clear tradeoff in the performance of the models between correctly pricing systematic risk and idiosyncratic risk. Linear factor models do a better job in most cases in pricing systematic risk than consumption‐based models but the reverse is true for idiosyncratic risk.

Date: 2007
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