The Capital Asset Pricing Model (CAPM) suggests that the market risk premium should be positively related to the market systematic risk as measured by the market variance. However, the empirical evidence is conflicting. While some studies find a significantly positive relation, others find an...

We model a microstructure effect on daily security returns, embodied by zero returns and the bid-ask spread, and derive a closed-form solution for the resulting bias in the estimated idiosyncratic volatility. Our empirical tests show that controlling for the bias eliminates the ability of...