Idiosyncratic Volatility and Risk-Adjusted Returns: Evidence from the Swedish Stock Market

Sammanfattning: Classic financial theory says that an investor should not be compensated for holding diversifiable risk, and that no relation between diversifiable risk and returns should exist. However, research has shown diversifiable risk, or idiosyncratic volatility, to be both positively and negatively related to returns, depending on the application. The purpose of this thesis is to examine the relation between idiosyncratic volatility and returns in the Swedish stock market. Using a sample consistently containing nearly all Swedish listed stocks from July, 1994, through December, 2013, and measuring idiosyncratic volatility relative to the Fama-French three-factor model, we show that there is a significant negative relation between idiosyncratic volatility and risk-adjusted returns in the Swedish stock market between February and December months. Additionally, we show that when the smallest stocks are excluded, there is a negative relation between idiosyncratic volatility and risk-adjusted returns in the Swedish stock market throughout the year.