Interest Rates, Inflation and the Value of Growth Options

Posted: 16 Oct 1998

See all articles by Kathleen T. Hevert

Kathleen T. Hevert

Babson College - Finance Division

Robyn McLaughlin

Suffolk University - Department of Finance

Robert A. Taggart

Boston College - Carroll School of Management; National Bureau of Economic Research (NBER)

Abstract

A company's investment opportunities are analogous to options, and options react differently to interest rate changes than other types of assets. We examine growth option sensitivity to inflation-induced changes in interest rates using a binomial model. We find that growth options are generally less sensitive to these rate changes than assets in place, but contrary to the usual call option intuition, the value of growth options frequently decreases as interest rates increase. The magnitude (and sign) of their interest sensitivity depends critically on how much of those changes in expected inflation rates can be "flowed through" to changes in the project's nominal cash flows.

JEL Classification: G31, G32

Suggested Citation

Hevert, Kathleen T. and McLaughlin, Robyn and Taggart, Robert A., Interest Rates, Inflation and the Value of Growth Options. 1998 Special Issue of the The Quarterly Review Of Economics And Finance; I. Extensions to the Traditional Capital Budgeting Framework. Available at SSRN: https://ssrn.com/abstract=129129

Kathleen T. Hevert

Babson College - Finance Division

121 Tomasso Hal
Babson Park, MA 02457-0310
United States
781-239-4630 (Phone)

Robyn McLaughlin (Contact Author)

Suffolk University - Department of Finance ( email )

8 Ashburton Place-Beacon Hill
Frank Sawyer School of Management
Boston, MA 02108-2770
United States
617-573-8396 (Phone)
617-573-8345 (Fax)

Robert A. Taggart

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Dept. of Finance
Chestnut Hill, MA 02467
United States
617-552-4113 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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