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Idiosyncratic Risk and the Cross-Section of Expected Stock Returns: Evidence from Nigeria

By Godwin Chigozie Okpara and Nathaniel Chinedum Nwezeaku

Abstract

Capital Asset Pricing Model (CAPM) builds on the portfolio theory and predicts that all investors hold the market portfolio in equilibrium and as such only systematic risks is priced. Yet empirical evidences on this important relation have been yielding mixed results. While some show that idiosyncratic risk can as well be priced, others contradict this. In investigating whether idiosyncratic risks can be priced in the Nigerian stock market, we employed two-step estimation procedures, namely the time series procedure to determine the beta and idiosyncratic risk for each of the companies and the cross-sectional estimation procedure used on EGARCH model to investigate the impact of these risks on the stock market returns. Our result reveals that systematic risk is priced while the idiosyncratic risk is not priced. Thus, investors in the Nigerian stock market seem to fully diversify away firms specific risk while holding market portfolio. The study also found that volatility clustering is not quite persistent but there exists asymmetric effect in the stock market. That is unexpected drop in price (bad news) increases predictable volatility more than unexpected increase in price (good news) of similar magnitude

Year: 2013
OAI identifier: oai:CiteSeerX.psu:10.1.1.321.4037
Provided by: CiteSeerX
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