I am studying idiosyncratic volatility. After applying the Fama Frech 3 Factor model with its Marktet, SMB and HML factors I want to build a factor based on idiosyncratic volatility.
Can I just build a portfolio including the highest idiosyncratic volatility assets and one with the lowest idiosyncratic volatility and subtract those from each other ?
My factor would then be:
IVOL factor = excess return of highest IVOL portfolios - excess returns of lowest IVOL portfolios
I could either used the 20% highest/lowest or just build the median and then assign them to one of the portfolios.
I am not sure if this approach is correct.