April 23, 2016
Motivated by mixed evidence related to the pricing of measures of risk, we investigate the information content of innovations in implied idiosyncratic volatility. Using both cross-sectional and time-series methodologies, we find that innovations in implied idiosyncratic volatility explain future returns for a sample of 2,864 optionable firms examined during the 1999-2010 sample period. We find that long-short portfolios formed using innovations in implied idiosyncratic volatility produce much larger abnormal returns than long-short portfolios formed using the level of implied idiosyncratic volatility.