Idiosyncratic volatility effect and analyst recommendations

The present study examines the contribution of the analysts to the Idiosyncratic Volatility (IVOL) effect. It finds that the negative IVOL effect is more prominent in the stocks covered by the analysts than in the non-covered stocks, as the high IVOL stocks attract favorable recommendations. The simultaneous impact of consensus recommendations and IVOL on the subsequent returns is negative. Furthermore, the favorable recommendations for high IVOL stocks are prominently visible when the firm size is small. Institutional ownership and market sentiment do not significantly impact the analysts' recommendations for high IVOL stocks. The analyst recommendations continue to be optimistically biased towards IVOL stocks over a period of time. Thus, it can be inferred that the favorable analyst recommendations contribute toward negative IVOL spread. The findings draw attention to the inefficient information dissemination by the analysts. The favorable recommendations can be explained by a mix of behavioral biases and incentive structures.