Is idiosyncratic risk priced? The international evidence

We find a positive and significant relation between forecasted idiosyncratic volatility and returns in a large international database covering 57 countries with over three million firm–month observations from July 1995 to June 2016. Our empirical results reveal substantial cross-country variation in the magnitude of the idiosyncratic risk premiums. Consistent with classic asset pricing theory (e.g., Markowitz (1959); Merton (1987)), we find that idiosyncratic risk premiums are positively associated with investor impediments to portfolio diversification. Specifically, the significant relation between idiosyncratic risk and returns is attenuated by stock market development, broader access to high quality information, and lower transaction costs