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A New Measure for Idiosyncratic Risk Based on Decomposition Method

Author

Listed:
  • Meng-Horng Lee

    (RHB Investment Bank Bhd, Level 3A, Tower One, RHB Centre, Jalan Tun Razak, Kuala Lumpur 50400, Malaysia)

  • Chee-Wooi Hooy

    (School of Management, Universiti Sains Malaysia, Penang 11800, Malaysia)

  • Robert Brooks

    (Department of Econometrics & Business Statistics, Monash University Caulfied, 26 Sir John Monash Drive, Caulfield East, VIC 31445, Australia)

Abstract

This paper introduces an alternate measure of idiosyncratic risk leveraged from the decomposition method to further eliminate the residual systematic risk inherent in the factor asset pricing model. Combining both complementary techniques contributes to a more comprehensive firm-level idiosyncratic risk that is crucial in both portfolio diversification and alpha investing. We focus our result on the idiosyncratic risk estimations and their behaviour on 36 emerging markets covering 39 industries. We show that the new measure exhibits a declining trend across time, consistent with the fact that emerging markets are becoming more integrated with the increased level of common effect across time.

Suggested Citation

  • Meng-Horng Lee & Chee-Wooi Hooy & Robert Brooks, 2023. "A New Measure for Idiosyncratic Risk Based on Decomposition Method," JRFM, MDPI, vol. 16(1), pages 1-8, January.
    • Handle: RePEc:gam:jjrfmx:v:16:y:2023:i:1:p:43-:d:1030315
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    References listed on IDEAS

    as
    1. Merton, Robert C, 1987. "A Simple Model of Capital Market Equilibrium with Incomplete Information," Journal of Finance, American Finance Association, vol. 42(3), pages 483-510, July.
    2. Mardi Dungey & Stan Hurn & Shuping Shi & Vladimir Volkov, 2019. "Information Flow in Times of Crisis: The Case of the European Banking and Sovereign Sectors," Econometrics, MDPI, vol. 7(1), pages 1-20, January.
    3. Javier Vidal-García & Marta Vidal & Sabri Boubaker & Riadh Manita, 2019. "Idiosyncratic risk and mutual fund performance," Annals of Operations Research, Springer, vol. 281(1), pages 349-372, October.
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    Cited by:

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