Price informativeness: a potential explanation for the idiosyncratic volatility puzzle

Price informativeness is the amount of private information incorporated into stock prices and measured by (Formula presented.) from regressions of stock returns on systematic risk factors. While (Formula presented.) is closely related with idiosyncratic volatility, it is not interchangeable because magnitude of systematic volatility simultaneously changes. By controlling for the systematic volatility using the double-sorting portfolio approach, we suggest a potential involvement of price informativeness with the idiosyncratic volatility puzzle. Both cross-sectional evidence of monotonic and inverse relationship between idiosyncratic volatility and (Formula presented.) and time-series evidence of disappearing alphas of the low-minus-high idiosyncratic volatility portfolios during recessions support an explanation of the idiosyncratic volatility puzzle in association with price informativeness.