Can Idiosyncratic Risk Matter? Evidence from China Stock Market

A crucial issue in asset pricing research is: Does idiosyncratic risk really matter? That is can idiosyncratic risk forecast the return on market? According to traditional portfolio theory, investors could diversify their assets and delete the idiosyncratic risk, thus the idiosyncratic risk doesn't matter in asset pricing. This paper take a new look at the predictability of stock market returns and idiosyncratic risk measures. We find an insignificant positive relation between idiosyncratic risk and the return on China stock market in the long run. These relations persist after we control for macroeconomic variables known to forecast the stock market. Our research will provide good foundation for China's asset pricing research.