This paper aims to investigate whether idiosyncratic volatility is priced in returns of equity funds while controlling for fund size and return momentum.
Following Fama and French (1993), an idiosyncratic volatility mimicking factor and a fund-size factor are constructed. The pricing ability of this idiosyncratic volatility mimicking factor is investigated in the context of Carhart (1997).
Idiosyncratic volatility is an important pricing factor even when controlling for fund size and momentum. In addition, idiosyncratic volatility is strongly and positively associated with the momentum effect. Further, when controlling for the association between the momentum effect and idiosyncratic volatility, the explanatory power of the momentum factor almost disappears, which suggests the pricing of idiosyncratic volatility mediates momentum and returns.
These findings imply that both the idiosyncratic volatility factor and the fund-size factor should not be ignored by fund managers when evaluating the performance of the equity funds.
