Risk components in UK cross-sectional equities: evidence of regimes and overstated parametric estimates

We study the behavior and interaction of systematic and idiosyncratic components of risk in a cross-section of U.K. stocks. We find no clear evidence of a trend in any component of total risk, but we document different “regimes” in the behavior of each component of total risk, in their correlation patterns and thus in their contribution to aggregate risk. Comparing parametric and non-parametric estimates of residual risk, we find the former to significantly overstate diversifiable risk, opposite to some previous findings for the U.S. market, with the difference being very large especially when we include an industry component.