The Idiosyncratic Volatility in Euro Zone Firms: Evolution, Cross-Sectional Relation with Returns

Abstract

This paper discusses the behaviour of the time series and the pricing of the idiosyncratic risk in 10 Eurozone economies from January 2000 to June 2018. We identify as well factors upon which depend the idiosyncratic risk premium. Our results show evidence of a common component within these countries’ aggregate idiosyncratic volatilities. Using Fama and MacBeth cross-sectional regressions, we observe a positive relationship between the idiosyncratic volatility and expected stock returns denying the idiosyncratic risk puzzle found by Ang et al. (2006). By performing Pooled OLS and radomn effects models, the results indicate that under-diversification proxies have a significant impact on the idiosyncratic risk premium.