.ISSN (e) 1759-7331
(print) 1759-7323
Quantitative Economics
An open-access journal in quantitative economics
Journal of the
Econometric Society
Font Size:  Small  Medium  Large

Quantitative Economics, Volume 12, Issue 2 (May 2021)

Is idiosyncratic risk conditionally priced?

Rajnish Mehra, Sunil Wahal, Daruo Xie

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.



Idiosyncratic risk factor models risk premium asset pricing G11 G12

Full Text: Print View Supplementary code PDF (Print)