Can Growth Options Explain the Trend in Idiosyncratic Risk?

Posted: 10 Oct 2006

See all articles by Charles Cao

Charles Cao

Pennsylvania State University

Timothy T. Simin

Pennsylvania State University

Jing Zhao

Portland State University - The School of Business

Multiple version iconThere are 2 versions of this paper

Abstract

While recent studies document increasing idiosyncratic volatility over the past four decades, an explanation for this trend remains elusive. We establish a theoretic link between growth options available to managers and the idiosyncratic risk of equity. Empirically both the level and variance of corporate growth options are significantly related to idiosyncratic volatility. Accounting for growth options eliminates or reverses the trend in aggregate firm specific risk. These results are robust for different measures of idiosyncratic volatility, different growth option proxies, across exchanges, and through time. Finally, our results suggest that growth options explain the trend in idiosyncratic volatility beyond alternative explanations.

Keywords: Idiosyncratic volatility, growth options, real options

JEL Classification: G31, G32, G12, G10

Suggested Citation

Cao, Charles and Simin, Timothy T. and Zhao, Jing, Can Growth Options Explain the Trend in Idiosyncratic Risk?. Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=936209

Charles Cao

Pennsylvania State University ( email )

Department of Finance
Smeal College of Business
University Park, PA 16802
United States
814-865-7891 (Phone)
814-865-3362 (Fax)

HOME PAGE: http://www.personal.psu.edu/qxc2/cao.html

Timothy T. Simin (Contact Author)

Pennsylvania State University ( email )

University Park, PA 16802
United States
814-865-3457 (Phone)

HOME PAGE: http://timsimin.net

Jing Zhao

Portland State University - The School of Business ( email )

631 SW Harrison St.
Portland, OR 97201
United States

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