March 3, 2017
This paper explains the negative relation between the realized idiosyncratic volatility (IVOL) and expected returns. Using implicit information from the cross-section of options we extract expectations about the volatility of idiosyncratic volatility (IVOLVOL) in an almost model-free fashion. We show that IVOL is mean-reverting and that IVOLVOL serves as proxy for the meanreversion speed. Running double sorts on both measures reveals no differences in returns or alpha if the mean-reversion is low.