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The Conditional Pricing of Systematic and Idiosyncratic Risk in the UK Equity Market

  • John Cotter

    (UCD School of Business, University College Dublin)

  • Niall O'Sullivan

    (School of Economics and Centre for Investment Research, University College Cork)

  • Francesco Rossi

    (UCD School of Business, University College Dublin)

We test whether firm idiosyncratic risk is priced in a large cross-section of U.K. stocks. A distinguishing feature of our paper is that our tests allow for a conditional relationship between systematic risk (beta) and returns in our tests, i.e., conditional on whether the excess market return is positive or negative. We find strong evidence in support of a conditional beta/return relationship which in turn reveals conditionality in the pricing of idiosyncratic risk. We find that idiosyncratic risk is significantly negatively priced in stock returns in down-markets. Although perhaps initially counter-intuitive, we describe the theoretical support for such a finding in the literature. Our results also reveal a strong role for liquidity, size and momentum factors in explaining the cross-section of U.K. stock returns.

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File URL: http://www.ucd.ie/geary/static/publications/workingpapers/gearywp201403.pdf
File Function: First version, 2014
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Paper provided by Geary Institute, University College Dublin in its series Working Papers with number 201403.

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Length: 22 pages
Date of creation: 19 Feb 2014
Date of revision:
Handle: RePEc:ucd:wpaper:201403
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