Model Selection and Relationship between Idiosyncratic Volatility and Expected Stock Returns: Evidence from Chinese A-share Market

With the daily data and monthly data of stock market for January 1, 2000 to March 31, 2011 as research sample, use Fama-French three factor regression and EGARCH(1,1) model to estimate idiosyncratic risk, the relationship between idiosyncratic risk and the return of stocks is analyzed based on the cross-sectional regression analysis method. Using Fama-French three factor regression to estimate idiosyncratic risk, a strongly statistically significant positive relation between idiosyncratic risk and the return of stocks is found. Using EGARCH(1,1) model to estimate idiosyncratic risk, there is a strongly statistically significant negative relation between idiosyncratic risk and the weighted return of stocks. Moreover, size, turnover, illiquidity, book-to-market ratio and is positively related to return of stocks, momentum and is negatively related to return of stocks. Two different models (Fama-French Three-factor Model and EGARCH Model) indicate that no robustly significant relationship exists between idiosyncratic volatility and expected return.