Misvaluation of Investment Options
61 Pages Posted: 9 Aug 2016 Last revised: 3 Aug 2018
Date Written: August 1, 2018
We study whether investment options are correctly priced. We build a real options model of optimal investment under uncertainty and structurally estimate it to classify stocks into undervalued and overvalued based on the difference between observed and model-implied firm values. A long-short strategy that buys most undervalued and shorts most overvalued stocks generates annualized alphas ranging from 10% to 17%. This relation is only present in subsamples of growth firms. We use a range of tests to determine whether this return differential is due to mispricing or a unique growth options risk.
Keywords: Misvaluation, Investment Options, Optimal Investment, Demand Uncertainty, Future Returns, Structural Estimation
JEL Classification: G14, G32
Suggested Citation: Suggested Citation