Turan G. Bali and Nusret Cakici
This paper tests the empirical performance of a model-independent measure of aggregate idiosyncratic risk introduced by Bali and Cakici (2004) in the intertemporal capital asset pricing framework. The results indicate a significantly positive relation between the equal-weighted average stock volatility and the value-weighted portfolio returns on the NYSE/AMEX/NASDAQ stocks for the sample period of 1963:08–1999:12.We show that this result is driven by small stocks traded on the NASDAQ. In addition, the positive risk-return tradeoff does not exist for the extended sample of 1963:08–2004:12 and for portfolios of NYSE/AMEX and NYSE stocks. More importantly, we find almost no evidence of a significant link between the value-weighted portfolio returns and various measures of the value-weighted average idiosyncratic volatility.