Any major theory/model that considers return due to idiosyncratic risk?

Question

Are there any classical, major theories/models that consider positive return due to idiosyncratic risk? For example, CAPM only considers return due to systemic risk but not idiosyncratic risk. If there are no major theories/models that fit the criterion, are there perhaps unorthodox ones worth mentioning? I would be grateful for references. (I am a novice in asset pricing, so pardon if the question is too basic.)

Answer 1

Hi,

Sharpe ratio, a popular measure of investment performance or even expected performance, uses total risk (systematic risk plus idiosyncratic risk) in the denominator.

You can read more about it on Investopedia.

Any model that uses sigma (standard deviation) rather than Beta is obviously considering idiosyncratic risk.

I hope this helps!

Regards,

Sujith