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Working Paper 2006-036A

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"The Relation between Time-Series and Cross-Sectional Effects of Idiosyncratic Variance on Stock Returns in G7 Countries"
by Hui Guo, and Robert Savickas

This paper suggests that CAPM-based idiosyncratic variance (IV) correlates negatively with future stock returns because it is a proxy for loadings on discount-rate shocks in Campbell’s (1993) ICAPM. The ICAPM also implies that there are important links between the time-series and cross-sectional IV effects. For example, the coefficients on conditional stock market variance and value-weighted average IV obtained from the time-series regressions reflect loadings on stock market returns and discount-rate shocks, respectively; therefore, they should help explain the cross section of stock returns. Moreover, we expect a close relation between the IV and book-to-market effects because recent studies show that the latter also reflects intertemporal pricing. These conjectures are strongly supported by the G7 countries’ data.

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Category > Applied Econometrics
Category > Finance
Category > Monetary Policy/Macroeconomics
Author > Hui Guo