Recognition effect on the relation of idiosyncratic volatility and return

abstractAccording to Merton (1987), idiosyncratic volatility pricing is mainly concerned with unknown stocks which have limited investor base. However, there is no trace of recognition effect study in experimental research of IVOL puzzle. Thus, ignoring the recognition effect could be one of the effective components in the puzzling behavior of idiosyncratic volatility. Therefore, in the present study, we try to explain the effect of recognition on idiosyncratic risk pricing. In this regard, first, the effect of recognition on the relationship between idiosyncratic risk and stock returns has been tested based on double sort portfolio study and Fama-Macbeth regression. Then, the proposed approach of Hou and Loh (2016) is applied to evaluate the amount of recognition effect on the relationship between idiosyncratic risk and stock returns in the Tehran stock exchange during (1384-1398). Results indicate a positive relationship between idiosyncratic risk and return. Moreover, show that recognition can explain up to 70% of the relationship between idiosyncratic risk and return.Keywords: unsystematic volatility, idiosyncratic risk, cognition effect, asset pricing