Idiosyncratic Volatility, Growth Options, and the Cross-Section of Returns

68 Pages Posted: 10 Nov 2007 Last revised: 7 Apr 2020

See all articles by Alexander Barinov

Alexander Barinov

University of California Riverside

Georgy Chabakauri

London School of Economics and Political Science

Date Written: April 6, 2020

Abstract

The paper shows that the value effect and the idiosyncratic volatility (IVol) discount (Ang et al., 2006) arise because growth firms and high IVol firms beat the CAPM during the periods of increasing aggregate volatility, which makes their risk low. All else equal, growth options' value increases with volatility, and this effect is stronger for high IVol firms, for which both growth options take a larger fraction of the firm value and firm volatility responds more to aggregate volatility changes. The three-factor ICAPM with the market factor, the market volatility risk factor (FVIX) and the average IVol factor (FIVol) completely explains the value effect and the IVol discount. The three-factor ICAPM also explains why those anomalies are stronger for firms with high short sale constraints.

Keywords: idiosyncratic volatility discount, growth options, aggregate volatility risk, value premium, anomalies, real options

JEL Classification: G12, G13, E44

Suggested Citation

Barinov, Alexander and Chabakauri, Georgy, Idiosyncratic Volatility, Growth Options, and the Cross-Section of Returns (April 6, 2020). Available at SSRN: https://ssrn.com/abstract=1028869 or http://dx.doi.org/10.2139/ssrn.1028869

Alexander Barinov (Contact Author)

University of California Riverside ( email )

900 University Ave.
Anderson Hall
Riverside, CA 92521
United States
585-698-7726 (Phone)

HOME PAGE: http://faculty.ucr.edu/~abarinov/

Georgy Chabakauri

London School of Economics and Political Science ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://personal.lse.ac.uk/CHABAKAU/

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