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Idiosyncratic Volatility and the Expected Stock Returns for Exploring the Relationship with Panel Threshold Regression

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  • Mu-Shun Wang

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    Abstract

    This paper utilizes panel threshold regression to study the impact of idiosyncratic risk of stock returns on the Taiwan Security Market over the period from 2000 to 2011, during which there has been a noticeable increase idiosyncratic volatility. An innovative panel threshold regression model is applied to test the panel threshold effect of idiosyncratic risk on expected stock returns. The results support Merton’s (J Financ 42:579–590, 1987 ) investor recognition hypothesis and confirm that a threshold effect does exist. This study shows that it is possible to identify the definitive level beyond which a further increase in idiosyncratic volatility does not improve proportional expected stock returns. Some important policy implications arise from these findings. The conditional distribution of expected stock returns is allowed to vary across low volatility states. The evidence suggests that in Taiwan, idiosyncratic risk is a predictor of future market returns based upon threshold value during the lower variance state. In contrast, when the threshold value is exceeded, the relation between idiosyncratic risk and expected stock returns is not statistically significant. Copyright Springer Science+Business Media New York 2013

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    Bibliographic Info

    Article provided by Springer in its journal Asia-Pacific Financial Markets.

    Volume (Year): 20 (2013)
    Issue (Month): 2 (May)
    Pages: 113-129

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    Handle: RePEc:kap:apfinm:v:20:y:2013:i:2:p:113-129

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    Web page: http://springerlink.metapress.com/link.asp?id=102851

    Related research

    Keywords: Idiosyncratic risk; Expected stock return; Panel threshold regression model; Volatility index; Fama and French multifactor model;

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