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Arbitrage pricing theory for idiosyncratic variance factors
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Renault, Eric, van der Heijden, Thijs and Werker, Bas J. M (2023) Arbitrage pricing theory for idiosyncratic variance factors. Journal of Financial Econometrics, 21 (5). pp. 1403-1442. doi:10.1093/jjfinec/nbac008 ISSN 1479-8409.
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Official URL: https://doi.org/10.1093/jjfinec/nbac008
Abstract
We develop an Arbitrage Pricing Theory framework extension to study the pricing of squared returns/volatilities. We analyze the interplay between factors at the return level and those in idiosyncratic variances. We confirm the presence of a common idiosyncratic variance fac- tor, but do not find evidence that this represents a missing risk factor at the (linear) return level. Thereby, we consistently identify idiosyncratic returns. The price of the idiosyncratic variance factor identified by squared returns is small relative to the price of market variance risk. The quadratic pricing kernels induced by our model are in line with standard economic intuition.
Item Type: | Journal Article | ||||||||
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Divisions: | Faculty of Social Sciences > Economics | ||||||||
Journal or Publication Title: | Journal of Financial Econometrics | ||||||||
Publisher: | Oxford University Press | ||||||||
ISSN: | 1479-8409 | ||||||||
Official Date: | September 2023 | ||||||||
Dates: |
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Volume: | 21 | ||||||||
Number: | 5 | ||||||||
Page Range: | pp. 1403-1442 | ||||||||
DOI: | 10.1093/jjfinec/nbac008 | ||||||||
Status: | Peer Reviewed | ||||||||
Publication Status: | Published | ||||||||
Access rights to Published version: | Open Access (Creative Commons) | ||||||||
Date of first compliant deposit: | 4 March 2022 | ||||||||
Date of first compliant Open Access: | 17 May 2022 | ||||||||
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