Correlations, Value Factor Returns, and Growth Options

83 Pages Posted: 15 Nov 2019 Last revised: 15 Mar 2020

See all articles by Lorenzo Schoenleber

Lorenzo Schoenleber

Frankfurt School of Finance & Management gemeinnützige GmbH

Date Written: November 6, 2019

Abstract

Ex ante (expected) average equity market correlation is linked to the differential correlation dynamics of growth and value firms, as well as the value premium. It predicts returns on the value factor, returns of growth firms, and the changes in growth options within an economy for horizons up to one year. A production-based asset-pricing model supports the existence of a homogeneous correlation among stocks with similar growth characteristics, depending on the prevailing idiosyncratic firm variance, increasing in the value of growth options and, hence, is connected to the value premium. Due to its link to growth options and the value premium, implied correlation serves as a leading procyclical state variable. Value Index--based implied correlations improve the predictability of value-related factors.

Keywords: option-implied correlations, production model, value premium, present value of growth options, factor return predictability, option-implied information, trading strategy, diversification, factor risk

JEL Classification: G11, G12, G13, G17

Suggested Citation

Schönleber, Lorenzo, Correlations, Value Factor Returns, and Growth Options (November 6, 2019). Available at SSRN: https://ssrn.com/abstract=3480606 or http://dx.doi.org/10.2139/ssrn.3480606

Lorenzo Schönleber (Contact Author)

Frankfurt School of Finance & Management gemeinnützige GmbH ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

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