Three Essays on Stock Returns and Idiosyncratic Risk

In this thesis, I study three aspects of idiosyncratic risk at the aggregate level. First, I examine the cross-sectional properties of the common factor in idiosyncratic volatility. Particularly, in Chapter 2, I replicate and extend the work of Herskovic, Kelly, Lustig and Van Nieuwerburgh (2016), which shows that the idiosyncratic volatility of individual firms has a strong factor structure and that the innovation in common idiosyncratic volatility (CIV) is priced in the cross-section of stock returns. Next, I explore the relation between stock idiosyncratic volatility and stock liquidity at the aggregate level. In Chapter 3, I document the role of stock liquidity in the findings of Chapter 2 and identify a corresponding factor structure in liquidity. Finally, I investigate the role of aggregate idiosyncratic risk in predicting the future market returns. In Chapter 4, I show a comprehensive study of average risk across stocks in predicting the subsequent market returns. Controlling market risk in the regression reflects the predictability of average risk across stock that is beyond market risk. This chapter considers various measures of risk including variance, skewness, kurtosis, and the composite of these moments variables such as tail risk, which is measured by value at risk (VaR) and expected shortfall (ES). Overall, the thesis concludes by confirming the crucial role which idiosyncratic risk plays in the asset pricing at an aggregate level. Future avenues for research are proposed including driven factors of aggregated idiosyncratic volatility and further studies into idiosyncratic tail risk and its impact on expected returns