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Idiosyncratic Risk, Investor Base, and Returns

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  • Doina C. Chichernea
  • Michael F. Ferguson
  • Haimanot Kassa

Abstract

type="main"> Using four different proxies for a firm's investor base we demonstrate that idiosyncratic risk premiums are larger for neglected stocks and smaller or economically insignificant for visible stocks. Since neglected stocks have greater idiosyncratic volatility (IV), the total IV risk premium (price × quantity) for neglected stocks will be greater than that of visible stocks. Additionally, we find a positive size effect and negative beta effect after controlling for IV. Overall, our results provide strong support for Merton's theory that market segmentation induced by incomplete information is an important component of the influence of IV in the cross-section of returns.

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  • Doina C. Chichernea & Michael F. Ferguson & Haimanot Kassa, 2015. "Idiosyncratic Risk, Investor Base, and Returns," Financial Management, Financial Management Association International, vol. 44(2), pages 267-293, June.
    • Handle: RePEc:bla:finmgt:v:44:y:2015:i:2:p:267-293
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