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Have European Stocks Become More Volatile? An Empirical Investigation of Idiosyncratic and Market Risk in the Euro Area

  • Colm Kearney
  • Valerio Poti

We examine the dynamics of idiosyncratic risk, market risk and return correlations in European equity markets using weekly observations from 3515 stocks listed in the 12 Euro area stock markets over the period 1974-2004. Similarly to Campbell, Lettau, Malkiel and Xu (2001), we find a rise in idiosyncratic volatility, implying that it now takes more stocks to diversify away idiosyncratic risk. Contrary to the United States , however, market risk is trended upwards in Europe and correlations are not trended downwards. Both the volatility and correlation measures are pro-cyclical, and they rise during times of low market returns. Market and average idiosyncratic volatility jointly predict market wide returns, and the latter impact upon both market and idiosyncratic volatility. This has asset pricing and risk management implications.

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Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp132.

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Date of creation: 23 May 2006
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Handle: RePEc:iis:dispap:iiisdp132
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  7. Barberis, Nicholas & Thaler, Richard, 2003. "A survey of behavioral finance," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 18, pages 1053-1128 Elsevier.
  8. Li Jin & Stewart C. Myers, 2004. "R-Squared Around the World: New Theory and New Tests," NBER Working Papers 10453, National Bureau of Economic Research, Inc.
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