The Dual Effect of Idiosyncratic Volatility on Stock Pricing and Return

The estimated relation between idiosyncratic volatility and realized return captures its relations with both expected return and the mispricing-related component due to its dual effect on stock pricing. The sign of its relation with the mispricing-related component is indeterminate. Empirically, its relation with the mispricing-related component dominates its relation with expected return. Hence one cannot infer the sign of its relation with expected return from its estimated relation with realized return. Moreover, its estimated relation with realized return varies with research design choices and even switches sign due to their effects on its relation with the mispricing-related component