Volatility Momentum

High idiosyncratic volatility (IV) stocks follow predictable return pattern after exhibiting large ex ante returns: a period of underreaction and low returns is superseded by persistent high returns. This pattern is robust and economically significant: it may be interpreted as informationally inefficient arrival of risk premia. Short-term negative IV-return relation is explained by profit taking by informed investors. Initial underreaction is linked to boundedly rational asset pricing story: uninformed investors hold on to underperforming high IV stocks in anticipation of recovering losses in turn-of-the-year trading. Consistently with the information hypothesis of the January effect, returns of stocks high in lagged IV are shown to be an important driver of this anomaly. Stocks void of ones high in lagged IV yield attenuated small firm effect. Returns to high momentum stocks are shown to be related to lagged IV rather than IV as previously postulated