Investment, Idiosyncratic Risk, and Growth Options

51 Pages Posted: 24 Feb 2021

See all articles by Clark Liu

Clark Liu

Tsinghua University - PBC School of Finance

Shujing Wang

Tongji University

Date Written: September 1, 2020

Abstract

We provide evidence that growth options play an important role in determining the negative relation between corporate investment and idiosyncratic risk in the absence of agency problem. A simple real options model predicts that the negative relation between corporate investment and idiosyncratic risk is a U-shaped function of the level of idiosyncratic risk: investment responds the most when idiosyncratic risk is at the intermediate level. And the negative relation is stronger when firms possess more growth options. Our results are robust when we control for the effect of managerial risk aversion, supporting the view that firms' optimal response to uncertainty is an important driving force behind the negative investment-idiosyncratic risk relation.

Keywords: Investment; Idiosyncratic Risk; Growth Options; Agency Problem; Managerial Risk Aversion

JEL Classification: G31; G32

Suggested Citation

Liu, Clark and Wang, Shujing, Investment, Idiosyncratic Risk, and Growth Options (September 1, 2020). Journal of Empirical Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3783590 or http://dx.doi.org/10.2139/ssrn.3783590

Clark Liu (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

Shujing Wang

Tongji University ( email )

Shanghai
China

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