Idiosyncratic Risk Puzzle Solved: Not All Investors Are The Same
| Nov 20th, 2011 | Filed under: Alpha Strategies, CAPM / Alpha Theory, Performance, Analytics & Metrics, Today's Post | By: cfaille |
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A mystery often disappears – or at least becomes smaller and more manageable – if you break into down into its component parts. That is the Hercule Poirot-like conclusion of a recent paper by three scholars at the Universidad Carlos III
The Puzzle
Intuition (codified by many models) suggests that investors have to be bribed to accept risk, so that there ought to be a positive link for any given class of security between the amount of risk, and thus the measurement of volatility, on the one hand, and expected return on the other.
A puzzle arises, then, from empirical research indicating that “idiosyncratic” volatility, that is, the volatility due to the characteristics of a specific security, is negatively correlated with return once one passes the mid-point of the range of volatility. More…
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Author Bio:
Christopher Faille is a Jamesian pragmatist. William James has taught him, for example, that "you can say of a line that it runs east, or you can say that it runs west, and the line per se accepts both descriptions without rebelling at the inconsistency."
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