Madison Scholar Jason Fink Presents Finance Research

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Jason FinkMadison Scholar, Chandler/Universal Professor of Banking and Professor of Finance Jason Fink recently presented his research on Understanding the Role of Idiosyncratic Volatility in Finance.

The Madison Scholar Award is awarded by the faculty in the College of Business in recognition of the cumulative accomplishments of an individual, with emphasis given to scholarly work done at JMU.  Recipients are nominated by their colleagues or department and a committee selects the recipient.

Fink described how returns on assets are driven by both systematic and idiosyncratic factors, though classical finance theory asserts that the crucial drivers of asset prices are the systematic risks. Systematic risk is vulnerability to events that affect aggregate outcomes, such as broad market returns.

In comparison, idiosyncratic risk is the risk of price changes due to the unique circumstances of a specific security. Classical theory suggests that this risk can be virtually eliminated from a portfolio through diversification—holding multiple securities means the movements of individual securities "cancel out."

Fink explored the question of how important idiosyncratic volatility is in explaining expected returns. He finds that idiosyncratic risk explains about 75% of market fluctuation, indicating it is of first order of importance when considering risky assets.

Although portfolio diversification lessens the risk, recent research finds it is difficult to hold a well diversified portfolio.

He noted that Bennett and Sias (2011) find it is impossible to have a true diversified portfolio; with hundreds, even thousands of stocks, one still can’t get away from idiosyncratic risk.

Fink presented a theory in which the links between expected returns and idiosyncratic volatility are established and explored.

He also talked about informed versus uninformed investors as relevant in the linkages between expected returns and idiosyncratic risk+. The existence of informed traders in the market will reduce the expected return. The interactions of idiosyncratic volatility and proportion of informed trading are an important determination of cost of capital.

Published: Friday, April 3, 2015

Last Updated: Thursday, October 20, 2016

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