Growth Options and Dynamic Risk: An Empirical Evaluation

45 Pages Posted: 3 Sep 2008

See all articles by Gregory W. Brown

Gregory W. Brown

University of North Carolina (UNC) at Chapel Hill - Finance Area

Michael T. Cliff

Analysis Group

Multiple version iconThere are 2 versions of this paper

Date Written: September 2, 2008

Abstract

Recent asset pricing research claims that "real options'" models generate dynamic risks related to firm investment policy and provide a rational explanation for size and value effects. We examine the empirical success of these dynamic beta models using both simulations and data from U.S. equity markets. Our simulation analysis shows that estimating dynamic betas is challenging even when the true model is known. In actual data we find little evidence that theories of real growth options explain standard pricing anomalies or conditional pricing puzzles such as SEO underperformance. Stock returns do not have the proper conditional covariances with the market portfolio, even though firm characteristics do behave in accordance with the real options models.

Keywords: real options, growth, dynamic beta

JEL Classification: G12

Suggested Citation

Brown, Gregory W. and Cliff, Michael T., Growth Options and Dynamic Risk: An Empirical Evaluation (September 2, 2008). Available at SSRN: https://ssrn.com/abstract=1262487 or http://dx.doi.org/10.2139/ssrn.1262487

Gregory W. Brown

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Michael T. Cliff (Contact Author)

Analysis Group ( email )

800 17th St, N.W.
Suite 400
Washington, DC 20006
United States
(202) 530-2010 (Phone)

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