Idiosyncratic Risk and REIT Returns

The volatility of a stock returns can be decomposed into market and firm-specific volatility, with the former commonly known as systematic risk and the later as idiosyncratic risk. This study examines the relevance of idiosyncratic risk in explaining the monthly cross-sectional returns of REIT stocks. Contrary to the CAPM theory, a significant positive relationship is found between idiosyncratic volatility and the cross-sectional returns. This suggests that firm-specific risk matters in REIT pricing. The regression results further show that once idiosyncratic risk is controlled for in the asset-pricing model, the size and book-to-market equity ratio factors ceased to be significant. The explanatory power of the momentum effect remains robust in the presence of idiosyncratic risk.