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Misvaluation of Investment Options

68 Pages Posted: 9 Aug 2016 Last revised: 25 Apr 2017

Evgeny Lyandres

Boston University

Egor Matveyev

Massachusetts Institute of Technology (MIT) - Sloan School of Management; University of Alberta - Department of Finance and Statistical Analysis

Alexei Zhdanov

Pennsylvania State University

Date Written: April 2017

Abstract

We study whether investment options are correctly priced. We build a real options model of optimal investment in the presence of demand uncertainty. We structurally estimate the model and classify stocks into undervalued and overvalued based on the difference between observed and model-implied firm values. A long-short strategy that buys undervalued and shorts overvalued stocks generates annualized alphas between 10% and 17%. This relation is only present in subsamples of firms with high proportions of investment options. We interpret these findings as evidence of misvaluation of investment options, leading to mispricing in equity markets that is gradually corrected over time.

Keywords: Misvaluation, Investment Options, Optimal Investment, Demand Uncertainty, Future Returns, Structural Estimation

JEL Classification: G14, G32

Suggested Citation

Lyandres, Evgeny and Matveyev, Egor and Zhdanov, Alexei, Misvaluation of Investment Options (April 2017). Available at SSRN: https://ssrn.com/abstract=2819652

Evgeny Lyandres (Contact Author)

Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States
617-3582279 (Phone)

Egor Matveyev

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-633
Cambridge, MA 02142
United States

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32B Business Building
Edmonton, Alberta T6G 2R6
Canada

Alexei Zhdanov

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

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

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