Yes / A key prediction of the Capital Asset Pricing Model (CAPM) is that idiosyncratic risk is not priced by investors because in the absence of frictions it can be fully diversified away. In the presence of constraints on diversification, refinements of the CAPM conclude that the part of idiosyncratic risk that is not diversified should be priced. Recent empirical studies yielded mixed evidence with some studies finding positive correlation between idiosyncratic risk and stock returns, while other studies reported none or even negative correlation. We revisit the problem whether idiosyncratic risk is priced by the stock market and what are the probable causes for the mixed evidence produced by other studies, using monthly data for the US market covering the period from 1980 until 2013. We find that one-period volatility forecasts are not significantly correlated with stock returns. The mean-reverting unconditional volatility, however, is a robust predictor of returns. Consistent with economic theory, the size of the premium depends on the degree of 'knowledge' of the security among market participants. In particular, the premium for Nasdaq-traded stocks is higher than that for NYSE and Amex stocks. We also find stronger correlation between idiosyncratic risk and returns during recessions, which may suggest interaction of risk premium with decreased risk tolerance or other investment considerations like flight to safety or liquidity requirements. The difference between the correlations of the idiosyncratic volatility estimators used by other studies and the true risk metric the mean-reverting volatility is the likely cause for the mixed evidence produced by other studies. Our results are robust with respect to liquidity, momentum, return reversals, unadjusted price, liquidity, credit quality, omitted factors, and hold at daily frequency. / National Research Foundation of Korea (2016S1A2A2912265)

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Credit spread is the extra risk-reward that an investor is bearing for investing in corporate bonds instead of government bonds. Structural models, which are simple in their framework, fail to explain the occurring credit spread and underestimate the predicted credit spread. Hence, the need for new models and exploration of systematic and idiosyncratic variables arose. The present paper aims to investigate if the predictability of lower-medium investment grade bonds and non-investment grade bonds credit spread can be improved by incorporating systematic and idiosyncratic variables into a fixed effect panel data regression model, and whether the selected variables’ significance has high influence on credit spread or not. Initial results showed that fixed effect panel data regression model underperforms the structural models and under predicts the actual credit spread. The applied model explained 13.5% of the lower-medium investment grade bonds credit spread and 8.5% of non-investment grade bonds. Further, systematic variables have higher influence on lower-medium investment grade bonds and idiosyncratic variables have higher influence on non-investment grade bonds. The predictability of credit spread can be improved by employing correct explanatory variables which are selected based on the characteristics of the sample size.

Most papers in empirical finance implicitly or explicitly assume the same price of risk, for each priced systematic risk factor, across all risky assets within a given domestic market. In doing so, they rely on the assumption that markets are domestically integrated and, as such, that the price of risk is determined independently of individual investors attitude towards risk. This is true in frictionless markets where investors have complete information, homogenous beliefs, and hold the mean-variance efficient combination of the market portfolio and a risk-free asset. However, investors might not hold the market portfolio because of exogenous reasons. In fact, several recent papers have provided evidence that US investors do not, holding instead vastly undiversified portfolios. There are two main implications to the above. First, if one group of investors does not hold the market portfolio, then the remaining set of investors will also not be able to hold the market portfolio and will rationally expect to be compensated for bearing idiosyncratic risk. Therefore, idiosyncratic risk will be priced in expected returns. Second, the price of risk need not be the same across all assets in which case domestic markets are not integrated. In the first essay titled "Is Idiosyncratic Volatility Really priced?" I show that the positive relation between idiosyncratic volatility (IV) and returns found by Fu (2009) only exists for firms that are difficult to arbitrage. The relation between IV and returns is strong for small and illiquid stocks, but decreases with size and liquidity and becomes non-existent for the largest and most liquid firms. Furthermore, zero-cost portfolios based on IV and size do not yield positive returns when conservative trading costs are considered. This evidence is consistent with an efficient market, in which arbitragers exploit profitable investment opportunities and by doing so they prevent systematic mispricing in financial markets. In the second essay titled "Are the U.S. Equity Markets Domestically Integrated?" I investigate whether the three main U.S. equity markets are domestically integrated by comparing the price of commonly used risk factors across the NYSE, Amex, and Nasdaq. I find that the markets have significantly different prices of risks for several risk factors, indicating that the markets are segmented. The magnitude of the difference is both statistically and economically significant, and is not due to arbitrage constraints or model misspecification. Instead, I find evidence consistent with the investor-segmentation hypothesis, in which different investors choose to hold different subsets of firms and demand different prices of risk among the different groups of securities. I do not find that segmentation is restricted to a specific time period. On the contrary, it is present in all sub-periods. In contrast to the results regarding the pricing of idiosyncratic volatility, these results highlight the value of diversification and suggest that domestic equity markets are not fully efficient.

In this dissertation, I explore the impact of idiosyncratic risk on asset returns. The first essay examines how idiosyncratic risk affects the cross-section of stock returns. I use an exponential GARCH model to forecast expected idiosyncratic volatility and employ a combination of the size effect, value premium, return momentum and short-term reversal to measure relative mispricing. I find that stock returns monotonically increase in idiosyncratic risk for relatively undervalued stocks and monotonically decrease in idiosyncratic risk for relatively overvalued stocks. This phenomenon is robust to various subsamples and industries, and cannot be explained by risk factors or firm characteristics. Further, transaction costs, short-sale constraints and information uncertainty cannot account for the role of idiosyncratic risk. Overall, these findings are consistent with the limits of arbitrage arguments and demonstrate the importance of idiosyncratic risk as an arbitrage cost. The second essay studies the cross-sectional determinants of delta-hedged stock option returns with an emphasis on the pricing of volatility risk. We find that the average delta-hedged option returns are significantly negative for most stocks, and they decrease monotonically with both total and idiosyncratic volatility of the underlying stock. Our results are robust and cannot be explained by the Fama-French factors, market volatility risk, jump risk, or the effect of past stock return and volatility-related option mispricing. Our results strongly support a negative market price of volatility risk specification that is proportional to the volatility level. Reflecting this volatility risk premium, writing covered calls on high volatility stocks on average earns about 2% more per month than selling covered calls on low volatility stocks. This spread is higher when it is more difficult to arbitrage between stock and option. / text

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This dissertation presents three different closely related topics on the value of eco-friendliness in the financial market. The first essay attempts to estimate hedonic stock price model to find a contemporaneous relationship between stock return and firms’ environmental performance and recover the value of investor’s willingness to pay of eco-friendliness. This study follows stock and environmental performances of the 500 largest US firms from 2009 to 2012. The firms’ environmental data come from the Newsweek Green Ranking, both aggregate measures: green ranking (GR) and green score (GS), and disaggregate measures: environmental impact score (EIS), green policy and performance score (GPS), reputation survey score (RSS), and environmental disclosure score (EDS). The results show a non-linear relationship between environmental variables and stock return, i.e. upside down bowl shape or increasing in decreasing rate. That means for low green ranking firms the marginal effect is positive while for high green ranking firms the marginal effect is negative. The investor’s willingness to pay (WTP) for a greener stock for firms in the lowest 25 green ranking, on average, is 0.0096% higher stock price. The second essays attempt to determine if a firm’s environmental performance affects future systematic risk. Systematic risk measures an individual stock’s volatility relative to the market price. This study also uses the Newsweek Green Ranking’s environmental variables. The results show significant evidence of a non-linear relationship between green variables and systematic (market) risk, but the shape is not unanimous for all environmental variables. The shape of the relationship for green ranking (GR), for example, is U-shape. This means that for the firms in the bottom rank, improving rank will lower systematic (market) risk, and for the firms in the top rank improving rank will increase systematic (market) risk. On average the marginal effect for the firms in the bottom and top 25 firms are -0.2% and 0.09% respectively. The third essay is the effect of a firm’s environmental performances on a firm’s idiosyncratic risk. Idiosyncratic risk measures an individual stock’s volatility independent from the market price. This study also uses the Newsweek Green Ranking’s environmental variables. The results show significant non-linear relationships between environmental variables and idiosyncratic risk, even though there is no unanimous shape among the environmental variables. In the case of green ranking, for example, it has U-shape; for the firms in the bottom rank, improving green ranking will lower idiosyncratic risk and for firm in the top green ranking, improving green ranking will increase idiosyncratic risk. On average the marginal effect for firm in bottom and top 25 firms are -0.4% and 0.2% respectively.

Submitted by Fernando Luiz da Silva Filho (fernandoluiz.filho@gmail.com) on 2018-02-26T19:40:21Z No. of bitstreams: 1 Dissertação - Fernando Luiz da Silva Filho.pdf: 804671 bytes, checksum: 6c8b8f37f253d1fac5bb5b910bc53abc (MD5) / Rejected by Thais Oliveira (thais.oliveira@fgv.br), reason: Prezado Fernando, boa tarde. Para que possamos aprovar seu trabalho, será necessário que faça somente uma alteração, que seria retirar o acento do nome "Getulio". Por gentileza, altere e submeta novamente. Obrigada. Qualquer dúvida, entre em contato. on 2018-02-27T19:13:33Z (GMT) / Submitted by Fernando Luiz da Silva Filho (fernandoluiz.filho@gmail.com) on 2018-02-27T19:29:16Z No. of bitstreams: 1 Dissertação - Fernando Luiz da Silva Filho.pdf: 803387 bytes, checksum: 25e96115bcb32a527894d4c10f7b5913 (MD5) / Approved for entry into archive by Thais Oliveira (thais.oliveira@fgv.br) on 2018-02-27T19:50:20Z (GMT) No. of bitstreams: 1 Dissertação - Fernando Luiz da Silva Filho.pdf: 803387 bytes, checksum: 25e96115bcb32a527894d4c10f7b5913 (MD5) / Made available in DSpace on 2018-02-27T21:07:28Z (GMT). No. of bitstreams: 1 Dissertação - Fernando Luiz da Silva Filho.pdf: 803387 bytes, checksum: 25e96115bcb32a527894d4c10f7b5913 (MD5) Previous issue date: 2018-02-06 / Este trabalho tem como objetivo verificar a existência de retornos anormais acumulados (ou CARs) em momentos de anúncio de dividendos e relaciona-los com a volatilidade idiossincrática das empresas. Foram utilizados anúncios de 40 ações ordinárias de empresas não financeiras entre fevereiro de 1998 e junho de 2017, agrupadas entre variações positivas e negativas dos dividendos, excluindo pagamentos iniciais e omissões. Percebeu-se significância estatística nas médias dos retornos anormais calculados tanto para variações positivas quanto negativas de dividendos, indicando que o mercado recebe a informação de distribuição conforme a teoria da sinalização de dividendos. A volatilidade idiossincrática, utilizada como proxy de assimetria de informação, indicou que altas volatilidades remetem a retornos anormais maiores. O valor de mercado das empresas, também relacionado à assimetria informacional, é negativamente relacionado aos CARs, como indicado pela teoria econômica. Variáveis de controle adicionadas ao modelo referentes ao desempenho operacional das empresas não trouxeram, no geral, significância estatística. Foi notado ainda o indicio de diminuição da volatilidade idiossincrática um ano após os anúncios, suportando a ideia da sinalização como fonte de diminuição da assimetria de informação. / This research aims to verify the occurrence of cumulative abnormal returns (or CARs) at periods of dividend announcement and relates it to the idiosyncratic volatility of companies. Announcements for 40 common stocks of non-financial corporations between February 1998 and June 2017 were considered, excluding initial announcements and omissions. Then, the announcements were gathered by positive or negative dividend variations. The results show that the means of the abnormal returns calculated for both positive and negative dividend changes are statistically significant, indicating that the market receives the distribution information according to the theory of dividend signaling. The idiosyncratic volatility, used as a proxy for information asymmetry, indicated that high volatilities are associated with larger abnormal returns. The market value of companies, also related to informational asymmetry, is negatively related to the CARs, which is in accord with economic theorys. Overall, control variables related to company’s operational performance that were added in the model were not statistically significant. There was also evidence of decrease in idiosyncratic volatility one year after announcements, supporting the idea of signaling as a source of diminished information asymmetry.

This thesis consists of three empirical essays studying the capital market implications of the accounting for R&D costs. The first empirical study (Chapter 2) re-visits the debate over the positive R&D-returns relation. The second empirical study (Chapter 3) examines the risk relevance of current R&D accounting. The third empirical study (Chapter 4) explores the joint impact of R&D intensity and competition on the relative relevance of the idiosyncratic part of earnings. Prior research argues that the positive relation between current R&D activity and future returns is evidence of mispricing, a compensation for risk inherent in R&D or a transformation of the value/growth anomaly. The first empirical study contributes to this debate by taking into account the link between R&D activity, equity duration and systematic risk. This link motivates us to employ Campbell and Vuolteenaho (2004)'s intertemporal asset pricing model (ICAPM) which accommodates stochastic discount rates and investors' intertemporal preferences. The results support a risk based explanation; R&D intensive firms are exposed to higher discount rate risk. Hedge portfolio strategies show that the mispricing explanations is not economically significant. The second empirical study contributes to prior research on the value relevance of financial reporting information on R&D, by proposing an alternative approach which relies on a return variance decomposition model. We find that R&D intensity has a significant influence on market participants' revisions of expectations regarding future discount rates (or, discount rate news) and future cash flows (or, cash flow news), thereby driving returns variance. We extend this investigation to assess the risk relevance of this information by means of its influence on the sensitivity of cash flow and discount rate news to the market news. Our findings suggest R&D intensity is associated with significant variation in the sensitivity of cash flow news to the market news which implies that financial reporting information on R&D is risk relevant. Interestingly, we do not establish a similar pattern with respect to the sensitivity of discount news to the market news which may dismiss the impact of sentiment in stock returns of R&D intensive firms. The third empirical study examines the effect of financial reporting information on R&D to the value relevance of common and idiosyncratic earnings. More specifically, we investigate the value relevance of common and idiosyncratic earnings through an extension of the Vuolteenaho (2002) model which decomposes return variance into its discount rate, idiosyncratic and common cash flow news. We demonstrate that the relative importance of idiosyncratic over common cash flow news in explaining return variance increases with firm-level R&D intensity. Extending this analysis, we find that this relation varies with the level of R&D investment concentration in the industry. Those results indicate that the market perceives that more pronounced R&D activity leads to outcomes that enable the firm to differentiate itself from its rivals. However, our results also suggest that the market perceives that this relation depends upon the underlying economics of the industry where the firm operates.

Sustainability and Corporate Social Responsibility (CSR) are increasingly important subjects in today's society. To measure a company's Corporate Social Performance (CSP); the ESG-rating has been developed throughout the years. As investors and the public are starting to acknowledge a company's sustainable actions and the importance of these, more and more companies choses to be rated using ESG-rating. As the knowledge around the subject has started to increase, we want to find out if it affects the risk of a company or an investment? Theories relating to the topic, such as stakeholder theory, suggests that satisfying all of a company’s stakeholders creates value for a company. Previous studies in the topic has interpreted this as high ESG-ratings should equal lower risks for the company. Additionally, previous studies in the relationship between sustainability and profitability shows a positive correlation between the two, meaning that companies that incorporate sustainability in general have higher profits. The purpose of this study is to investigate if high ESG-ratings could lead to lower firm’s risk in Sweden. There has been a lot of previous research in the area, but none focusing on Sweden. The majority of the previous studies have concluded that there exists a negative relationship between CSP and a firm’s risk, which indicates that if a company would integrate CSR it could lower the risk. This study will include 145 Swedish companies with 2,610 firm-year observations from the period 2001-12-21 to 2019-12-31. The risk measures used are; Total Risk (Volatility), Systematic Risk (Beta) and Idiosyncratic Risk. As for the ESG-ratings, the data is obtained from ASSET4 from the database Thomson Reuters Eikon as the measure of CSP. Furthermore a multiple regression analysis is performed to statistically investigate the relationship between a company's ESG-rate (and the three pillars Environmental, Social and Governance) and risk. The study concluded that there exists a statistically significant positive relationship between Volatility and Idiosyncratic Risk and the ESG-score for Swedish firms. As for the individual pillars; Environmental (ENV), Social (SOC) and Governance (GOV); the result indicated that there existed a statistically significant positive relationship between Volatility and Idiosyncratic Risk with the two pillars; ENV and GOV, respectively. This suggests that the higher ESG-score, ENV and GOV-scores of Swedish firms the higher Volatility and Idiosyncratic Risk. Neither Volatility or Idiosyncratic risk showed a statistically significant relationship with the social pillar. Consequently we are not able to confirm the relationship between Volatility and Idiosyncratic Risk with the Social pillar. Regarding Beta, the study found no statistically significant relationship with the ESG-score, as well as for the individual pillars; Environmental, Social and Governance. Therefore we are not able to confirm a relationship for Beta and the ESG-score, ENV, SOC and GOV-scores. As a final remark this study concluded the opposite as for previous research and consequently this thesis has contributed with new knowledge within the area of ESG-rating and risk for Swedish companies.