Journal of Current Practice in Accounting and Finance (JCPAF)

VOLATILITY UNVEILED: DECIPHERING IDIOSYNCRATIC PATTERNS IN THE SRI LANKAN MARKET

Authors

  • Dr. Kasun S. Perera Department of Finance, Faculty of Management and Finance, University of Colombo, Sri Lanka
  • Dr. Anusha R. Silva

Abstract

The Capital Asset Pricing Model (CAPM) has been a cornerstone in asset pricing literature, assuming that investors hold well-diversified portfolios, making idiosyncratic volatility irrelevant for pricing stock returns. However, Merton (1987) contends that information asymmetries prevent investors from achieving full diversification, making idiosyncratic volatility a critical factor in asset pricing. Supporting this argument, Goetzmann and Kumar (2008) provide empirical evidence that a significant portion of investor portfolios in the United States consists of undiversified holdings.

This study reevaluates the traditional view by examining the role of idiosyncratic volatility in asset pricing, challenging the CAPM's assumption of perfect diversification. By considering the prevalence of undiversified portfolios, it explores how idiosyncratic volatility may indeed impact stock returns, shedding light on its relevance as a pricing factor. Through empirical analysis and theoretical insights, this research contributes to the ongoing discourse on asset pricing models and their applicability in real-world investment scenarios

Keywords:

Capital Asset Pricing Model (CAPM), Idiosyncratic Volatility, Asset Pricing, Information Asymmetry

Downloads

Published

2023-12-13

Issue

Vol. 14 No. 12 (2023): December

Section

Articles

How to Cite

Perera, K. S., & Silva, A. R. (2023). VOLATILITY UNVEILED: DECIPHERING IDIOSYNCRATIC PATTERNS IN THE SRI LANKAN MARKET. Journal of Current Practice in Accounting and Finance (JCPAF), 14(12), 1–10. Retrieved from https://zapjournals.com/Journals/index.php/Accounting-Finance/article/view/1650

License

Copyright (c) 2023 Dr. Kasun S. Perera, Dr. Anusha R. Silva

Creative Commons License

This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.

References

Abeysekera, A. P., & Nimal, P. D. (2016). The impact of the financial sector on asset pricing tests: Evidence from the Colombo Stock Exchange. Asian Journal of Finance & Accounting, 8(2), 113–124.

Abeysekera, A. P., & Nimal, P. D. (2017). The four-factor model and stock returns: Evidence from Sri Lanka. AfroAsian Journal of Finance and Accounting, 7(1), 1–15.

Amihud, Y. (2002). Illiquidity and stock returns: Cross-section and time-series effects. Journal of Financial Markets, 5(1), 31–56.

Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid-ask spread. Journal of Financial Economics, 17(2), 223– 249.

Ang, A., Hodrick, R. J., Xing, Y., & Zhang, X. (2006).The cross-section of volatility and expected returns, TheJournal of Finance, 61(1), 259–299.

Ang, A., Hodrick, R. J., Xing, Y., & Zhang, X. (2009). High idiosyncratic volatility and low returns: International and further US evidence, Journal of Financial Economics, 91(1), 1–23.

Bali, T. G., & Cakici, N. (2008). Idiosyncratic volatility and the cross section of expected returns?Journal of Financial and Quantitative Analysis, 43(1), 29–58.

Bali, T. G., Cakici, N., & Whitelaw, R. F. (2011). Maxing out: Stocks as lotteries and the cross-section of expected returns. Journal of Financial Economics, 99(2), 427–446.

Bali, T. G., Engle, R. F., & Murray, S. (2016). Empirical asset pricing: The cross section of stock returns. Hoboken, NJ: John Wiley & Sons, Inc.

Carhart, M. M. (1997). On persistence in mutual fund performance.The Journal of Finance, 52(1), 57–82.

Fabozzi, F. J., Gupta, F., & Markowitz, H. M. (2002). The legacy of modern portfolio theory. The Journal of Investing, 11(3), 7–22.

Fama, E. F. (1998). Market efficiency, long-term returns, and behavioral finance.Journal of Financial Economics, 49(3), 283–306.

Fama, E. F., & French, K. R., (1992). The cross-section of expected stock returns. TheJournal of Finance, 47(2), 427–65.

Fama, E. F., & French, K. R., (1993).Common risk factors in the returns on stocks and bonds.Journal of Financial Economics, 33(1), 3–56.

Fama, E. F., & French, K. R. (2004). The capital asset pricing model: Theory and evidence. Journal of Economic Perspectives, 18(3), 25–46.

Fama, E. F., & French, K. R. (2012). Size, value, momentum in international stock returns. Journal of Financial Economics, 105, 457–472.

Fama, E. F., & French, K. R. (2015).A five-factor asset pricing model.Journal of Financial Economics, 116, 1–22.

Fu, F. (2009). Idiosyncratic risk and the cross-section of expected stock returns. Journal of Financial Economics, 91, 24– 37.

Goetzmann, W. N., & Kumar, A. (2008).Equity portfolio diversification.Review of Finance, 12(3), 433–463.

Hou, K., & Moskowitz, T. J. (2005). Market frictions, price delay, and the cross-section of expected returns. The Review of Financial Studies, 18(3), 981–1020.

Kumar, A. (2009). Who gambles in the stock market?. The Journal of Finance, 64(4), 1889–1933.

Kumari, J., Mahakud, J., &Hiremath, G. S. (2017). Determinants of idiosyncratic volatility: Evidence from the Indian stock market. Research in International Business and Finance, 41, 172–184.

Markowitz, H. (1952). Portfolio selection. The Journal of Finance, 7(1), 77–91.

Merton, R. C. (1987). A simple model of capital market equilibrium with incomplete information.The Journal of Finance, 42(3), 483–510.

Miller, M. H., & Scholes, M. S. (1982). Dividends and taxes: Some empirical evidence. The Journal of Political Economy, 90(6), 1118–1141.

Nelson, D. B. (1991). Conditional heteroskedasticity in asset returns: A new approach. Econometrica, 59(2), 347–370.

Newey, W. K. & West, K. D. (1987).A simple, positive semi-definite, hetroskedasticity and autocorrelation consistent covariance matrix.Econometrica 55, 703-708.

Pastor, L., & Stambaugh, R. F. (2003). Liquidity risk and expected stock returns. The Journal of Political Economy, 111(3), 642–685.

Pukthuanthong-Le, K., &Visaltanachoti, N. (2009). Idiosyncratic volatility and stock returns: a cross country analysis. Applied Financial Economics, 19(16), 1269–1281.

Ross, S. A. (1976). The arbitrage theory of capital asset pricing. Journal of Economic Theory, 13(3), 341–360.

Samarakoon, L. P. (1997). Predictability of short-horizon returns in the Sri Lankan stock market. Sri Lankan Journal of Management, 1(3), 207–224

Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. The Journal of Finance,19(3), 425–442.

Sriyalatha, M. A. K. (2008). Does the All Share Price Index represent the Colombo stock market?.The Meijo Review, 9(3), 75–90.