The cross-section of dynamics in idiosyncratic risk

This paper investigates change in idiosyncratic volatility estimated by individual security. We find that a significant portion of securities contains long periods of increasing or decreasing idiosyncratic risk. The series of idiosyncratic risk though are unlikely to have a life-long deterministic trend, and can be often characterized by a long memory process. Our evidence suggests that the proportions of securities with rising and declining risk continuously change, which in turn affects fluctuations of the market average. This evidence implies that an average idiosyncratic risk may not be a good representative of the dynamics in risk of a given security. We demonstrate that the companies with an increasing idiosyncratic risk tend to have deteriorating performance, and investigate factors behind these empirical observations. (C) 2011 Elsevier B.V. All rights reserved.