Growth Options and Related Stock Market Anomalies: Profitability, Distress, Lotteryness, and Volatility

Abstract

Growth options increase idiosyncratic skewness and reduce risk exposure, and thereby create the appearance of profitability, distress, lotteryness, and volatility anomalies, influencing their returns via the channel of idiosyncratic skewness. To capture these effects, we estimate expected idiosyncratic skewness due to growth options reflecting investors’ expectation about the firm’s mix of growth options versus assets-in-place. We find that investors require a positive premium to hold stocks of inflexible firms with low growth options and hence negative expected idiosyncratic skewness, and that a newly proposed skewness factor based on growth options or firm inflexibility explains the aforementioned anomalies.

Keywords: Stock Market Anomalies, Stock Returns, Growth Options, Profitability, Lotteryness, Distress, Idiosyncratic Volatility, Idiosyncratic Skewness

JEL Classification: G10, G11, G12