Date of Award
5-2015
Degree Type
Thesis
Degree Name
Master of Science (MS)
Department
Economics and Finance
Committee Chair(s)
Ben Blau
Committee
Ben Blau
Committee
Tyler Brough
Committee
Ryan Whitby
Abstract
The trade-off between risk and return is a fundamental principle in finance. In any finance class, one will likely hear the phrase, “the greater the risk, the greater the return.” The Capital Asset Pricing Model (CAPM), one of the most basic and well-known finance models, estimates the expected return of an asset assuming a positive relation between expected return and a single risk factor. Empirically, risk control variables such as the CAPM beta along with other risk factors associated with market cap, book-to-market ratio, and illiquidity are used when pricing assets. Finance is abundant in theories all supporting positive risk-return relationships. In spite of the general, intuitive risk-return relationship, several studies have empirically observed risk factors, including idiosyncratic volatility, to be negatively related to the future return on a stock (Ang, Hodrick, Xing, and Zhang (2006)). This counterintuitive relationship invokes the question why a risk variable such as idiosyncratic volatility would have a negative effect on expected returns when theory suggests that risk should have a positive relationship with expected return.
Recommended Citation
Cannon, Brad, "The Idiosyncratic Volatility Puzzle: A Behavioral Explanation" (2015). All Graduate Plan B and other Reports, Spring 1920 to Spring 2023. 466.
https://digitalcommons.usu.edu/gradreports/466
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