REITs and Idiosyncratic Risk

This study examines various determinants of idiosyncratic risk from the perspective of un-diversified REIT investors, managers holding options, other option holders, and arbitrageurs. Since real estate investment trusts (REITs) enjoy a unique organizational structure and tax status, the relevant determinants derived from the two-stage regression model are different from other industrial firms. Results suggest that efficiency, liquidity and earnings variability are the important determinants of idiosyncratic risk, whereas size and capital do not

Innovation and Idiosyncratic Risk

The paper studies whether “idiosyncratic riskâ€, i.e. the degree to which firm and industry specific returns are more volatile than aggregate market returns, is higher in innovative industries which are characterized by more risk and uncertainty. Volatility is studied both at the industry level (for 34 different industries from 1974-2003) and at the firm level (for 5 industries with different levels of innovativeness: biotech, pharmaceuticals, computers, textile, agriculture). Findings are mixed. A relationship between innovation and volatility emerges most strongly with firm level data, when firm dimension is accounted for, and when time varying volatility is explicitly studied via GARCH analysis. The latter highlights the distinctive behavior of returns during the course of the industry life-cycle.idiosyncratic risk, volatility, innovation, industry life cycle

Returns to private equity: idiosyncratic risk does matter!

Owners of private companies often invest a substantial share of their net worth in one company, which exposes them to idiosyncratic risk. For US companies we investigate whether owners require compensation for lack of diversification in the form of higher returns to equity. Exposure to idiosyncratic risk is measured as the share of the owner's net worth invested in the company. Equity returns are measured as the earnings rate and as capital gains. For both returns measures we find a positive and significant influence of exposure to idiosyncratic risk. This paper improves our understanding of returns to private equity. --returns to private equity,exposure to idiosyncratic risk,private companies

How Does Owners' Exposure to Idiosyncratic Risk Influence the Capital Structure of Private Companies?

This paper identifies the entrepreneur's exposure to idiosyncratic risk as an important determinant of the demand for loans and the capital structure. The analysis is based on a sample of small and medium-sized private companies from the United States. The exposure to idiosyncratic risk is approximated by the share of personal net worth invested in one company (SNWI). Exposure to idiosyncratic risk increases the cost of equity capital, since higher equity returns are required as compensation. This therefore makes bank financing more attractive. We find that SNWI increases both the demand for new bank loans and leverage substantially. --capital structure,exposure to idiosyncratic risk,private companies

Corporate bond prices and idiosyncratic risk: evidence from Australia

In this paper we investigate the bond price effect upon the information arrival of firm-specific idiosyncratic risk. We consider idiosyncratic dispersion and idiosyncratic volatility that capture, respectively, the direction of information and the magnitude of idiosyncratic risk. We find that idiosyncratic volatility does not affect bond prices, while the direction of idiosyncratic risk which reflects the favorable or unfavorable information exhibits impacts on bond prices. Idiosyncratic dispersion in the stock return of a firm in the preceding week, in general, is positively associated with bond price changes in the current week. This effect is most pronounced for firms exhibiting characteristics associated with lower default risk

Cross–Sectoral Variation in Firm–Level Idiosyncratic Risk

We estimate firm–level idiosyncratic risk in the U.S. manufacturing sector. Our proxy for risk is the volatility of the portion of growth in sales or TFP which is not explained by either industry– or economy–wide factors, or firm characteristics systematically associated with growth itself. We find that idiosyncratic risk accounts for about 90% of the overall uncertainty faced by firms. The extent of cross–sectoral variation in idiosyncratic risk is remarkable. Firms in the most volatile sector are subject to at least three times as much uncertainty as firms in the least volatile. Our evidence indicates that idiosyncratic risk is higher in industries where the extent of creative destruction is likely to be greater.Schumpeterian Competition, Creative Destruction, Product Turnover, R&D Intensity, Investment–Specific Technological Change

Ownership, Risk and Performance of Mutual Fund Management Companies

This paper compares the performance of mutual funds managed by publicly-traded management companies with those managed by private management companies. We find that publicly-traded management companies invest in riskier assets and charge higher management fees than do the funds managed by private management companies. The risk-adjusted returns of the mutual funds managed by publicly-traded management companies are also lower than those of the mutual funds managed by private management companies. This finding is consistent with both a risk spreading and agency cost argument. The paper also shows that the idiosyncratic risk of the publicly-traded management company's stock significantly differs from the idiosyncratic risk of the assets they manage, suggesting that previous research using the stock's idiosyncratic risk as a proxy for the idiosyncratic risk of the company's assets to study the determinants of publicly-traded companies' ownership concentration may be misleading.

How Does Owners' Exposure to Idiosyncratic Risk Influence the Capital Structure of Private Companies?

This paper identifies the entrepreneur's exposure to idiosyncratic risk as an important determinant of the capital structure of private companies. The exposure to idiosyncratic risk is approximated by the share of personal net worth invested in one company (SNWI). Exposure to idiosyncratic risk increases cost of equity capital since higher equity returns are required as compensation. This makes bank financing more attractive. We find that SNWI increases the demand for new bank loans whereas we cannot identify an effect on the supply. Equilibrium values of leverage increase significantly in SNWI but there is no effect on the equilibrium interest rate. --entrepreneurial investment,capital structure,underdiversification,private companies

IDIOSYNCRATIC RISK AND AUSTRALIAN EQUITY RETURNS

In this paper we investigate the relationship between portfolio returns and idiosyncratic risk for Australian stocks. We report that the portfolio with highest idiosyncratic volatility generates an average annual return of over 45%. We observe additionally that the outcome is consistent with an exponential growth process for stock prices. Further, consistent with Malkiel and Xu, we observe that a stock’s idiosyncratic volatility is inversely correlated with the size of the underlying firm. Thus, our model advances an interpretation of the Fama and French finding that portfolios of stocks of small firms offer superior risk-adjusted returns. Moreover, our findings challenge the portfolio theory of Markowitz (1959) and the asset-pricing model of Sharpe (1964).Idiosyncratic risk, Capital Asset Pricing Model, Size effect

Does idiosyncratic risk matter: another look

We show that the equal-weighted average stock volatility analyzed by Goyal and Santa-Clara (GS, 2003) forecasts stock returns because of its co-movements with stock market volatility. Moreover, contrary to the positive relation hypothesized by GS and many others, we find that the value-weighted average stock volatility is negatively related to future stock returns when combined with stock market volatility. This puzzling result reflects the fact that the alue-weighted average stock volatility is negatively correlated with the consumption-wealth ratio, and its predictive power vanishes if we control for the latter in the forecasting equation. The idiosyncratic volatility proposed by GS thus provides no information beyond the forecasting variables advocated by Guo (2003)2:26 PM 10/17/03Stock market ; Asset pricing