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Journal of Financial and Quantitative Analysis Vol. 60 No. 8 2025

Idiosyncratic Volatility and the ICAPM Covariance Risk

Bing Han1; Gang Li2

1 University of Toronto Rotman School of Management and Chinese University of Hong Kong · 2 Chinese University of Hong Kong CUHK Business School

Abstract

We show theoretically and empirically that the cross-section of stock return idiosyncratic volatilities contains useful information about the ICAPM. We construct a proxy cross-sectional bivariate idiosyncratic volatility (CBIV) for the covariance risk between the market and the unobserved hedge portfolio under the ICAPM. Consistent with the ICAPM pricing relation, CBIV is a robust and significant predictor of the equity risk premium. We further show that the return predictability of the tail index in Kelly and Jiang (2014) can be explained by the ICAPM covariance risk.

DOI
10.1017/s0022109025000195
Volume
60
Issue
8
Pages
3694-3721
Language
en
Sources
crossref openalex

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