Real Options, Volatility, and Stock Returns

49 Pages Posted: 8 Mar 2008 Last revised: 25 Mar 2013

See all articles by Gustavo Grullon

Gustavo Grullon

Rice University - Jesse H. Jones Graduate School of Business

Evgeny Lyandres

Tel Aviv University

Alexei Zhdanov

Pennsylvania State University

Date Written: 2012

Abstract

This paper provides evidence that the positive relation between firm-level stock returns and firm-level return volatility is due to real options that firms possess. Consistent with the theoretical prediction that the value of a real option should be increasing in the volatility of the underlying asset, we find that the positive volatility-return relation is much stronger for firms that are more likely to have more real options. We also find that the sensitivity of firm values to changes in volatility declines significantly after firms exercise their real options. Finally, we reconcile the aggregate-level evidence of a negative relation between returns and return volatility with the positive relation at the firm level by showing that the negative relation at the aggregate level may be due to aggregate market conditions that simultaneously affect both market returns and return volatility.

Keywords: Volatility, Risk, Stock Returns, Real Options

JEL Classification: G12, G31, G32

Suggested Citation

Grullon, Gustavo and Lyandres, Evgeny and Zhdanov, Alexei, Real Options, Volatility, and Stock Returns (2012). Journal of Finance, Vol. 67, pp. 1499-1536, 2012, Available at SSRN: https://ssrn.com/abstract=1101562 or http://dx.doi.org/10.2139/ssrn.1101562

Gustavo Grullon

Rice University - Jesse H. Jones Graduate School of Business ( email )

P.O. Box 2932
Houston, TX 77252-2932
United States
(713) 348-6138 (Phone)
(713) 348-6331 (Fax)

HOME PAGE: http://www.ruf.rice.edu/~grullon/

Evgeny Lyandres (Contact Author)

Tel Aviv University ( email )

Ramat Aviv
Tel-Aviv, 6997801
Israel
6400241 (Fax)

Alexei Zhdanov

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

HOME PAGE: http://www.alexeizhdanov.com

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