Idiosyncratic Risk: An Empirical Analysis, with Implications for the Risk of Relative-Value Trading Strategies

Author: Mr. Anthony J. Richards

This paper models the idiosyncratic or asset-specific return of an asset as the return on a portfolio that is long in that asset and short in other assets in the same class, thereby removing the common components of returns. This is the type of "hedged" position that is held by relative-value investors. Weekly returns data for seven different asset classes suggest that idiosyncratic risk is: higher at times of large return outcomes for the asset class as a whole; positively autocorrelated; and correlated across different asset classes. The implications for risk management are discussed.

Volume/Issue: Volume 1999 Issue 148

Publication date: November 1999

ISBN: 9781451856804

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Topics covered in this book

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Business and Economics , Banks and Banking , Finance , WP , asset class , return properties , returns-generating process , asset return , fixed income , returns share , Idiosyncratic Risk , Dispersion , Risk Management , Hedge Funds , component of return , return outcome , Stock markets , Stocks , Market risk , Securities markets , Emerging and frontier financial markets , East Asia

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Summary

This paper models the idiosyncratic or asset-specific return of an asset as the return on a portfolio that is long in that asset and short in other assets in the same class, thereby removing the common components of returns. This is the type of “hedged” position that is held by relative-value investors. Weekly returns data for seven different asset classes suggest that idiosyncratic risk is: higher at times of large return outcomes for the asset class as a whole; positively autocorrelated; and correlated across different asset classes. The implications for risk management are discussed.