I am working on a research project but am having some trouble wrapping my head around how I need to go about replicating two of key dependent variables from (Serfling, 2014).
Total Risk, defined as: the annualized standard deviation of daily stock returns during the fiscal year.
Idiosyncratic Risk, defined as: the annualized standard deviation of the residuals from the regression of daily stock returns on the Fama & French three factors estimated over the fiscal year.
I think I already know for Total Risk: 1. change in daily closing price to get daily stock returns, 2. STDEV of daily stock returns 3. calculate variance, i.e. square STDEV of daily stock returns 4. make assumption on number of trading days, i.e. 250 or 252 5. annualized variance, i.e. variance * number of trading days and, 6. SQRT of annualized variance.
Can anyone confirm this?
How do I go about doing calculating the idiosyncratic risk? I will have a larger data set spanning at least from 1992 till 2016, so I would have to be able to calculate idiosyncratic risk for many firm-years in Stata and/or Excel.
The main source of my confusion is that some people state: Total Risk - Systematic Risk = Idiosyncratic Risk but there is also the approach in the Alpha Architect link. I am not sure if they are the same, but it does not appear to be the case.
(Serfling, 2014) --> https://www.sciencedirect.com/science/article/pii/S092911991300148X