Idiosyncratic risk and expected returns: a panel data model with random effects

Abstract

This article utilizes panel data regression to explore the random effects between expected stock returns and idiosyncratic risk. We find a strong relation between idiosyncratic risk and the expected stock returns. The results are consistent with Fu's study (2009) and a documented relation exists between the expected stock return autocorrelation, the return reverse effects. This study reveals that idiosyncratic risk has a significantly positive impact on stock returns. It is shown that positive returns have more idiosyncratic volatility, indicating that past higher returns induce lower or negative returns. The results support Huang et al. (2010) stock return reversal effect, as well as Goyal and Santa-Clara's (2003), Bali et al. (2005) and Fu's (2009) hypothesis in which idiosyncratic risk has a positive impact on expected returns. We also find evidence that the FVIX (Mimicking Volatility Index) considering the robustness with high sensitivity to innovation. The aggregate volatility shows low past returns ...