Country-specific idiosyncratic risk and global equity index returns

Studies have claimed that the "idiosyncratic volatility puzzle" in the firm-level data can be explained by certain time-series properties of the firm-specific shocks. The absence of this puzzle in the country-level index data implies that the time-series properties of the country-specific shocks are different from those of the firm-specific shocks. We find that the differences are, first, lagged idiosyncratic volatility is a better proxy for expected idiosyncratic risk in the country-level data. Second, idiosyncratic skewness is not a significant factor determining country-level index returns. Finally, country-specific index returns show momentum, as opposed to return reversals documented in the firm-level data.