Abstract

This paper confirms the relationship between idiosyncratic risk and excess stock returns for Canadian equities. The relationship between returns and idiosyncratic risk is examined using Fama-MacBeth twostep methodology with a modified Carhart four-factor (five-beta) model. The Fama-MacBeth tests are conducted with and without the presence of control variables for liquidity (proxied by amortized spread or the illiquidity measure of Amihud) and firm-specific information embedded in stock prices (proxied by synchronicity and the zero-return&trade metric). The conditional relation between returns and idiosyncratic risk for Canadian stocks is robust and significant. Given the model dependencies and metrics, the paper posits this to a higher competitive environment, investor under-diversification, and lower market power faced by Canadian firms as compared to US firms.