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I calculate monthly idiosyncratic volatility as the standard deviation of residuals of a Fama-French regression on daily returns.

Now assume that within these daily returns there is a price hike due to an overreaction of the market. Does this automatically lead to a higher IVOL because the price is irrational and not due to systematic risk factors?

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  • $\begingroup$ Do you assume a single short-term event within your FF regression (e.g. the announcement of share repurchases, stock splits,...) or do you think of a long-term persistent overreaction and therefore a permanent misvaluation (starting within a single point of time in the estimation window)? $\endgroup$ – skoestlmeier Oct 4 '18 at 12:47

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