Can asset pricing models price idiosyncratic risk in U.K. stock returns?

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Abstract

I examine how well different linear factor models and consumption-based asset pricing models price idiosyncratic risk in U.K. stock returns. Correctly pricing idiosyncratic risk is a significant challenge for many of the models I consider. For some consumption-based models, there is a clear tradeoff in the performance of the models between correctly pricing systematic risk and idiosyncratic risk. Linear factor models do a better job in most cases in pricing systematic risk than consumption-based models but the reverse is true for idiosyncratic risk.
Original languageEnglish
Pages (from-to)507-535
Number of pages28
JournalFinancial Review
Volume42
Issue number4
DOIs
Publication statusPublished - 2007

Keywords

  • idiosyncratic risk
  • stochastic discount factor

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