Volatility risks and growth options

Hengjie Ai, Dana Kiku

Research output: Contribution to journalArticlepeer-review

18 Scopus citations

Abstract

We propose to measure growth opportunities by firms' exposure to idiosyncratic volatility news. Theoretically, we show that the value of a growth option increases in idiosyncratic volatility but its response to volatility of aggregate shocks can be either positive or negative depending on option moneyness. Empirically, we show that price sensitivity to variation in idiosyncratic volatility carries significant information about firms' future investment and growth even after controlling for conventional proxies of growth options such as bookto-market and other relevant firm characteristics. Consistent with our theoretical arguments, we also find that firm' exposure to aggregate volatility, while priced, does not help predict their future growth. Option-intensive firms identified using our idiosyncratic volatility-based measure earn a lower premium than do firms that rely more heavily on assets in place.

Original languageEnglish (US)
Pages (from-to)741-763
Number of pages23
JournalManagement Science
Volume62
Issue number3
DOIs
StatePublished - Mar 2016

Bibliographical note

Publisher Copyright:
© 2016 INFORMS.

Keywords

  • Asset pricing
  • Finance
  • Growth options
  • Idiosyncratic volatility

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