Idiosyncratic Volatility and the Expected Stock Returns for Exploring the Relationship with Panel Threshold Regression
 MuShun Wang
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This paper utilizes panel threshold regression to study the impact of idiosyncratic risk of stock returns on the Taiwan Security Market over the period from 2000 to 2011, during which there has been a noticeable increase idiosyncratic volatility. An innovative panel threshold regression model is applied to test the panel threshold effect of idiosyncratic risk on expected stock returns. The results support Merton’s (J Financ 42:579–590, 1987) investor recognition hypothesis and confirm that a threshold effect does exist. This study shows that it is possible to identify the definitive level beyond which a further increase in idiosyncratic volatility does not improve proportional expected stock returns. Some important policy implications arise from these findings. The conditional distribution of expected stock returns is allowed to vary across low volatility states. The evidence suggests that in Taiwan, idiosyncratic risk is a predictor of future market returns based upon threshold value during the lower variance state. In contrast, when the threshold value is exceeded, the relation between idiosyncratic risk and expected stock returns is not statistically significant.
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 Title
 Idiosyncratic Volatility and the Expected Stock Returns for Exploring the Relationship with Panel Threshold Regression
 Journal

AsiaPacific Financial Markets
Volume 20, Issue 2 , pp 113129
 Cover Date
 20130501
 DOI
 10.1007/s1069001291610
 Print ISSN
 13872834
 Online ISSN
 15736946
 Publisher
 Springer Japan
 Additional Links
 Topics
 Keywords

 Idiosyncratic risk
 Expected stock return
 Panel threshold regression model
 Volatility index
 Fama and French multifactor model
 Industry Sectors
 Authors

 MuShun Wang ^{(1)} ^{(2)}
 Author Affiliations

 1. Department of Finance and Banking, Kainan University, Taipei City, Taiwan
 2. No. 1 Kainan Road, LuzhuShiang, Taoyuan, 33857, Taiwan