Is Idiosyncratic Risk Conditionally Priced?

Rajnish Mehra, Sunil Wahal and Daruo Xie

No 22016, NBER Working Papers from National Bureau of Economic Research, Inc

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 with a positive state-dependent premium for idiosyncratic risk both in the US and in other developed markets.

JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2016-02
Note: AP
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Published as Rajnish Mehra & Sunil Wahal & Daruo Xie, 2021. "Is idiosyncratic risk conditionally priced?," Quantitative Economics, Econometric Society, vol. 12(2), pages 625-646, May.

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Journal Article: Is idiosyncratic risk conditionally priced? (2021)
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