Real Options and the Cross-Section of Expected Stock Returns

24 Pages Posted: 3 Sep 2012 Last revised: 9 Jan 2013

See all articles by Graeme Guthrie

Graeme Guthrie

Victoria University of Wellington - School of Economics & Finance

Multiple version iconThere are 2 versions of this paper

Date Written: January 9, 2013

Abstract

This paper surveys the theoretical literature investigating the effect of firms' investment flexibility on the cross-section of expected stock returns. Real options analysis derives firms' value-maximizing investment policies as functions of exogenous fundamental drivers of profitability and calculates firms' market values as functions of the same variables. These functions yield the relationship between expected stock returns and firm fundamentals. Several plausible explanations for the value premium --- the high average stock returns earned by firms with high book-to-market ratios --- emerge from this literature.

Keywords: expected stock returns, real options, value premium

JEL Classification: D92, G12, G31

Suggested Citation

Guthrie, Graeme, Real Options and the Cross-Section of Expected Stock Returns (January 9, 2013). Available at SSRN: https://ssrn.com/abstract=2140314 or http://dx.doi.org/10.2139/ssrn.2140314

Graeme Guthrie (Contact Author)

Victoria University of Wellington - School of Economics & Finance ( email )

P.O. Box 600
Wellington 6140
New Zealand
64 4 463 5763 (Phone)

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