Market States Matter on Idiosyncratic Risk!
Evidence from East Asian Markets
Jen-Sin Lee * and Chu-Yun Wei**
Abstract
Recent studies on risk have not only investigated the market risk, but have also gradually
explored idiosyncratic risk. For instance, Ang, Hodrick, Xing, and Zhang (2006, 2009), Fu
(2009) and Lee and Wei (2012) all point out that idiosyncratic risk significantly affects
expected short-run returns. This paper investigates whether the market states will affect
idiosyncratic risk and market risk, and further explores the relation between idiosyncratic risk
and expected short-run returns. The focus of this paper is on East Asian listed firms. We
distinguish the earthshaking crises as the market states and in contrast to the approach adopted
to measure idiosyncratic risk by Ang et al. (2006, 2009), we take into consideration the
threshold GARCH and exponential GARCH models for heteroskedasticity and the volatility
of a falling stock price.
Our main findings are as follows: (1) the High idiosyncratic risk in the crisis period
hypothesis is supported, and (2) the High idiosyncratic risk with low expected short-run
returns hypothesis is also supported. The findings imply that it is necessary to distinguish the
market states when investigating idiosyncratic risk. The idiosyncratic risks of firms in the
crisis period is negatively related to expected short-run returns, which supports Ang et al.
(2006, 2009). It means that investors should hold the last stock in non-crisis periods with low
idiosyncratic risk to earn high stock returns. The main reason for the empirical result of low
idiosyncratic risk with high expected short-run return is that risk-averse investors prefer low
idiosyncratic risk assets in the short run.
*
Dr. Jen-Sin Lee, Department of Finance, I-Shou University, Taiwan R.O.C.
E-mail address: jensinlee01@gmail.com Tel: +886-7-6577711# 5721; Fax: +886-7-6577056.
1, Sec 1, Syuecheng Rd, Dashu Township, Kaohsiung City, Taiwan R.O.C.
**
Corresponding author: Miss Chu-Yun Wei. Postgraduate Programs in Management, I-Shou University,
Taiwan R.O.C.
E-mail address: phoenix2366@gmail.com Tel: + 886-7-6577711#5013; Fax: +886-7-6577231.
1, Sec 1, Syuecheng Rd, Dashu Township, Kaohsiung City, Taiwan R.O.C.
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Key words: Idiosyncratic risk, Market State, threshold GARCH models, exponential GARCH models,
East Asian Markets.
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