Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk

Source: Campbell, J. Y., Lettau, M., Malkiel, B. G. & Xu, Y. (2001) · Journal of Finance 56(1), 1–43 · DOI: 10.1111/0022-1082.00318

The idea

Decompose the volatility of a typical common stock into **market, industry, and firm-specific

(idiosyncratic) components without estimating betas, and ask how each has evolved. Over 1962–1997**,

firm-level (idiosyncratic) volatility rose noticeably relative to market and industry volatility. As a

result, correlations among stocks fell, the market model's explanatory power for a typical stock

declined, and the number of stocks needed for a given level of diversification increased.

Firm-level volatility trended up over 1962–1997; market and industry volatility did not show a

comparable trend.

Average correlations among individual stocks declined, and the R² of the market model for a

typical stock fell — so more stocks are needed to achieve a given diversification.

All three volatility measures move together countercyclically and help predict GDP growth;

market volatility tends to lead the industry and firm series.

A foundational reference on idiosyncratic risk and diversification. It is essential background for the

idiosyncratic-volatility anomaly (Ang, Hodrick, Xing & Zhang 2006), for limits-to-arbitrage arguments

(more firm-specific risk makes arbitrage costlier), and for portfolio-construction intuition about how

many names are needed to diversify.

The variance decomposition is descriptive, not a risk model; it identifies a trend, not its cause

(new/younger listings, sectoral composition, and growth options are debated drivers).

The documented uptrend partly reverses in later samples, so the trend is sample-dependent.

Campbell, J., Lettau, M., Malkiel, B. & Xu, Y. (2001) — Have Individual Stocks Become More Volatile? — Journal of Finance

Ang, A., Hodrick, R., Xing, Y. & Zhang, X. (2006) — The Cross-Section of Volatility and Expected Returns — Journal of Finance

Bali, T., Cakici, N. & Whitelaw, R. (2011) — Maxing Out — Journal of Financial Economics

Provenance: verified/generated from the paper's full text.