Based On The Characteristics Of The Risk Of Stock Market Investment Strategy Research

The traditional portfolio theory and CAPM model suggest that idiosyncratic riskcan be avoided by diversified investment. However, due to transaction costs, riskappetite and other factors, investors in reality may not hold perfectly diversifiedportfolios, which may cause that they have to undertake the idiosyncratic risk. In thiscontext, this paper is starting from the problem of idiosyncratic risk and based onsystematic summary of theoretical and empirical research on the idiosyncratic risk,through the study of idiosyncratic risk and expected return, investors’ behavior,combined with the conclusions of behavioral finance; we build an investment strategyin stock market which is based on idiosyncratic risk. The main conclusions of this paperare as follows:Firstly, we study the relationship between idiosyncratic risk and expected return.After deduced by the formulas and models, we get the idiosyncratic risk-based pricingmodel which suggests that the expected return of the stock is not only affected by theimpact of systemic risk but also affected by the impact of idiosyncratic risk. This modelproves that idiosyncratic risk can be priced in expected return. Using EGARCH modelwhich can capture the time trend of volatility to estimate idiosyncratic risk, and theempirical research methods of cross-sectional regression analysis and portfolio analysis,we find that there is a positive relationship between idiosyncratic risk and expectedreturn, and the relationship stably exists in different time intervals. This study showsthat Chinese stock market does not exist the so-called "idiosyncratic volatilitypuzzle"which is result of ignoring the time series properties of idiosyncratic volatility.Secondly, this paper studies the impact of the behavior of institutional investorsagainst idiosyncratic risk and its risk premium. Through empirical research, we find thatinstitutions holding large stocks help reduce idiosyncratic risk; the lower proportion ofinstitutional investors holding the stock, the stock has greater idiosyncratic risk and moreexpected returns. This paper analyzes the relationship between idiosyncratic risk andexpected return from the view of institutional ownership, then further points out theimportance of investor diversification, and suggests that investor under-diversification leads to the positive pricing of idiosyncratic risk.Finally, we contruct an investment strategy in stock market which is based onidiosyncratic risk after combined the relevant theories of behavioral finance andconclusions of idiosyncratic risk. At the end of the analysis of momentum effect andreverse effects on idiosyncratic risk, we find that the reverse effect is more obvious inthe stocks with higher idiosyncratic risk. So we come to such an investment strategy:taking the momentum strategy for the low idiosyncratic risk stocks, and taking a reversestrategy for the high idiosyncratic risk stocks. After reviewing historical data, thisstrategy can significantly outperform the benchmark index.