Does Idiosyncratic Risk Have a Significant Impact on Return Probability? A Case Study of Borsa Istanbul 100 Stocks

Abstract

Most asset pricing models ignore idiosyncratic risk, or firm-specific risk, while it is one of the most critical determinants of asset pricing and stock returns. In this paper, we investigate the impact of idiosyncratic risk on the returns of stocks traded on the Borsa Istanbul using six different fixed effect panel tobit and four different fixed effect panel logit regression models. The results of logit models suggest that as idiosyncratic risk increases, probability of positive stock returns also increases. Furthermore, an increase in a stock's market sensitivity has a negative effect on the probability of positive returns, while an increase in the market-to-book ratio, firm size, and market return has positive effects on returns. In all models, the explanatory variables, including idiosyncratic risk, market-to-book ratio, firm size, and market return, have a positive effect on returns, except for the model where negative values of dependent variable are censored at zero.