Market Overreaction and Idiosyncratic Volatility Estimates

Summary

The document defines a monthly idiosyncratic volatility measure as the standard deviation of residuals from a Fama–French regression using daily returns. It asks whether a daily price jump caused by market overreaction would automatically increase this measure, on the grounds that the move is not explained by systematic risk factors.

The question highlights how unexplained return movements enter residual-based volatility estimates, but it does not provide an answer or empirical analysis. A price jump may contribute to larger residual variation if the factor model does not explain it; whether the monthly estimate rises depends on the size of the residual relative to the other daily residuals in that month. The text does not specify regression details, return treatment, or how overreaction is identified, so it does not establish that a move is irrational or quantify its effect.

Key ideas

• The stated monthly idiosyncratic volatility measure is the standard deviation of daily regression residuals.
• A return move not captured by the Fama–French factors can appear in the residual series.
• The document asks whether an overreaction-driven price hike raises the estimate but gives no conclusion.
• The effect depends on the residual’s size relative to the month’s other daily residuals.

Tags

# Idiosyncratic Volatility


# Idiosyncratic Volatility












I calculate monthly idiosyncratic volatility as the standard deviation of residuals of a Fama-French regression on daily returns.

Now assume that within these daily returns there is a price hike due to an overreaction of the market. Does this automatically lead to a higher IVOL because the price is irrational and not due to systematic risk factors?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.