Hostname: page-component-78c5997874-ndw9j Total loading time: 0 Render date: 2024-11-15T11:28:48.773Z Has data issue: false hasContentIssue false
  • English
  • Français

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

Published online by Cambridge University Press:  22 August 2019

Turan G. Bali ,
Luca Del Viva Open the ORCID record for Luca Del Viva [Opens in a new window] ,
Neophytos Lambertides  and
Lenos Trigeorgis
Turan G. Bali*
Affiliation:
Bali, turan.bali@georgetown.edu, Georgetown University McDonough School of Business
Luca Del Viva
Affiliation:
Del Viva, luca.delviva@esade.edu, Ramon Llull University ESADE Business School
Neophytos Lambertides
Affiliation:
Lambertides, n.lambertides@cut.ac.cy, Cyprus University of Technology
Lenos Trigeorgis
Affiliation:
Trigeorgis, lenos@mit.edu, University of Cyprus, King’s College London, and visiting scholar MIT Sloan School
*
Bali (corresponding author), turan.bali@georgetown.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

We provide new evidence on the economic role of growth options behind the profitability, distress, lotteryness, and volatility anomalies. We use idiosyncratic skewness to measure growth options and estimate expected idiosyncratic skewness capturing investors’ expectations 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 negative expected skewness and that a newly proposed skewness factor based on growth options explains the aforementioned anomalies. Thus, the new measure of expected idiosyncratic skewness may serve to reduce the number of anomalies in the literature.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 7 , November 2020 , pp. 2150 - 2180
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We are grateful for helpful comments and suggestions from an anonymous referee, Nicholas Baltas, Colin Clubb, Jennifer Conrad (the editor), George Constantinides, John Core, K. Ozgur Demirtas, Irene Karamanou, S. P. Kothari, Andreas Milidonis, Nikos Vafeas, and Kamil Yilmaz. We also benefited from discussions with seminar participants at the Multinational Finance Society Conference, Aalto University, ESADE Business School, Koc University, and Sabanci University. We thank Kenneth French, Lubos Pastor, and Robert Stambaugh for making data publicly available in their online data library. The financial support of AGAUR – SGR 2017-640, Banco Sabadell, and the Spanish Ministry of Science, Innovation and Universities (grant PGC2018–099700-A-100) is also acknowledged. All errors remain our responsibility.

References

Ai, H., and Kiku, D.. “Growth to Value: Option Exercise and the Cross Section of Equity Returns.” Journal of Financial Economics, 107 (2013), 325–349.CrossRefGoogle Scholar
Ai, H., and Kiku, D.. “Volatility Risks and Growth Options.” Management Science, 62 (2016), 741–763.CrossRefGoogle Scholar
Anderson, C. W., and Garcia-Feijóo, L.. “Empirical Evidence on Capital Investment, Growth Options, and Security Returns.” Journal of Finance, 61 (2006), 171–194.CrossRefGoogle Scholar
Anderson, M. C.; Banker, R. D.; and Janakiraman, S. N.. “Are Selling, General, and Administrative Costs ‘Sticky’?” Journal of Accounting Research, 41 (2003), 47–63.CrossRefGoogle Scholar
Ang, A.; Hodrick, R.; Xing, Y.; and Zhang, X.. “The Cross-Section of Volatility and Expected Returns.” Journal of Finance, 61 (2006), 259–299.CrossRefGoogle Scholar
Bali, T. G.; Brown, S.; Murray, S.; and Tang, Y.. “A Lottery Demand-Based Explanation of the Beta Anomaly.” Journal of Financial and Quantitative Analysis, 52 (2017), 2369–2397.CrossRefGoogle Scholar
Bali, T. G., and Cakici, N.. “Idiosyncratic Volatility and the Cross Section of Expected Returns.” Journal of Financial and Quantitative Analysis, 43 (2008), 29–58.CrossRefGoogle Scholar
Bali, T. G.; Cakici, N.; and Whitelaw, R. F.. “Maxing Out: Stocks as Lotteries and the Cross-Section of Expected Returns.” Journal of Financial Economics, 99 (2011), 427–446.CrossRefGoogle Scholar
Bali, T. G., and Engle, R. F.. “The Intertemporal Capital Asset Pricing Model with Dynamic Conditional Correlations.” Journal of Monetary Economics, 57 (2010), 377–390.CrossRefGoogle Scholar
Ball, R.; Gerakos, J.; Linnainmaa, J. T.; and Nikolaev, V.. “Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns.” Journal of Financial Economics, 121 (2016), 28–45.CrossRefGoogle Scholar
Berk, J. B.; Green, R. C.; and Naik, V.. “Optimal Investment, Growth Options, and Security Returns.” Journal of Finance, 54 (1999), 1553–1607.CrossRefGoogle Scholar
Bharath, S. T., and Shumway, T.. “Forecasting Default with the Merton Distance to Default Model.” Review of Financial Studies, 21 (2008), 1339–1369.CrossRefGoogle Scholar
Boyer, B.; Mitton, T.; and Vorkink, K.. “Expected Idiosyncratic Skewness.” Review of Financial Studies, 23 (2010), 169–202.CrossRefGoogle Scholar
Campbell, J.“Intertemporal Asset Pricing without Consumption Data.” American Economic Review, 83 (1993), 487–512.Google Scholar
Campbell, J. Y.; Hilscher, J.; and Szilagyi, J.. “In Search of Distress Risk.” Journal of Finance, 63 (2008), 2899–2939.CrossRefGoogle Scholar
Cao, C.; Simin, T.; and Zhao, J.. “Can Growth Options Explain the Trend in Idiosyncratic Risk?” Review of Financial Studies, 21 (2008), 2599–2633.CrossRefGoogle Scholar
Carhart, M. M.“On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 57–82.CrossRefGoogle Scholar
Carlson, M.; Fisher, A.; and Giammarino, R.. “Corporate Investment and Asset Price Dynamics: Implications for the Cross-Section of Returns.” Journal of Finance, 59 (2004), 2577–2603.CrossRefGoogle Scholar
Chava, S., and Purnanandam, A.. “Is Default Risk Negatively Related to Stock Returns?” Review of Financial Studies, 23 (2010), 2523–2559.CrossRefGoogle Scholar
Chen, L.; Novy-Marx, R.; and Zhang, L.. “An Alternative Three-Factor Model.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1418117 (2011).CrossRefGoogle Scholar
Conrad, J.; Kapadia, N.; and Xing, Y.. “Death or Jackpot: Why Do Individual Investors Hold Overpriced Stocks?” Journal of Financial Economics, 113 (2014), 455–475.CrossRefGoogle Scholar
Cooper, I.“Asset Pricing Implications of Nonconvex Adjustment Costs and Irreversibility of Investment.” Journal of Finance, 61 (2006), 139–170.CrossRefGoogle Scholar
Cooper, M. J.; Gulen, H.; and Schill, M. J.. “Asset Growth and the Cross-Section of Stock Returns.” Journal of Finance, 63 (2008), 1609–1651.CrossRefGoogle Scholar
Davis, J. L.; Fama, E. F.; and French, K. R.. “Characteristics, Covariances, and Average Returns: 1929 to 1997.” Journal of Finance, 55 (2000), 389–406.CrossRefGoogle Scholar
Del Viva, L.; Kasanen, E.; and Trigeorgis, L.. “Real Options, Idiosyncratic Skewness, and Diversification.” Journal of Financial and Quantitative Analysis, 52 (2017), 215–241.CrossRefGoogle Scholar
Dichev, I. D.“Is the Risk of Bankruptcy a Systematic Risk?” Journal of Finance, 53 (1998), 1131–1147.10.1111/0022-1082.00046CrossRefGoogle Scholar
Diether, K. B.; Malloy, C. J.; and Scherbina, A.. “Differences of Opinion and the Cross Section of Stock Returns.” Journal of Finance, 57 (2002), 2113–2141.10.1111/0022-1082.00490CrossRefGoogle Scholar
Erickson, T., and Whited, T. M.. “Measurement Error and the Relationship between Investment and q.” Journal of Political Economy, 108 (2000), 1027–1057.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Industry Costs of Equity.” Journal of Financial Economics, 43 (1997), 153–193.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Profitability, Investment and Average Returns.” Journal of Financial Economics, 82 (2006), 491–518.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “A Five-Factor Asset Pricing Model.” Journal of Financial Economics, 116 (2015), 1–22.CrossRefGoogle Scholar
Fama, E. F., and MacBeth, J.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607–636.CrossRefGoogle Scholar
French, K. R.; Schwert, G. W.; and Stambaugh, R. F.. “Expected Stock Returns and Volatility.” Journal of Financial Economics, 19 (1987), 3–29.CrossRefGoogle Scholar
Garlappi, L.; Shu, T.; and Yan, H.. “Default Risk, Shareholder Advantage, and Stock Returns.” Review of Financial Studies, 21 (2008), 2743–2778.CrossRefGoogle Scholar
Garlappi, L., and Yan, H.. “Financial Distress and the Cross-section of Equity Returns.” Journal of Finance, 66 (2011), 789–822.CrossRefGoogle Scholar
George, T. J., and Hwang, C.-Y.. “A Resolution of the Distress Risk and Leverage Puzzles in the Cross Section of Stock Returns.” Journal of Financial Economics, 96 (2010), 56–79.CrossRefGoogle Scholar
Gomes, J.; Kogan, L.; and Zhang, L.. “Equilibrium Cross Section of Returns.” Journal of Political Economy, 111 (2003), 693–732.CrossRefGoogle Scholar
Grullon, G.; Lyandres, E.; and Alexei, Z.. “Real Options, Volatility, and Stock Returns.” Journal of Finance, 64 (2012), 1499–1537.CrossRefGoogle Scholar
Harvey, C. R., and Siddique, A.. “Conditional Skewness in Asset Pricing Tests.” Journal of Finance, 55 (2000), 1263–1295.CrossRefGoogle Scholar
Haugen, R. A., and Baker, N. L.. “Commonality in the Determinants of Expected Stock Returns.” Journal of Financial Economics, 41 (1996), 401–439.CrossRefGoogle Scholar
Hou, K.; Mo, H.; Xue, C.; and Zhang, L.. “q 5.” Dice Center Working Paper No. 2018-10; Fisher College of Business Working Paper No. 2018-03-010 (2018).Google Scholar
Hou, K.; Xue, C.; and Zhang, L.. “Digesting Anomalies: An Investment Approach.” Review of Financial Studies, 28 (2015), 650–705.CrossRefGoogle Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 65–91.CrossRefGoogle Scholar
Jurado, K.; Ludvigson, S. C.; and Ng, S.. “Measuring Uncertainty.” American Economic Review, 105 (2015), 1177–1216.CrossRefGoogle Scholar
Kester, C. W.“Today’s Options for Tomorrow’s Growth.” Harvard Business Review, (1984), 1–20.Google Scholar
Kumar, A.“Who Gambles in the Stock Market?” Journal of Finance, 64 (2009), 1889–1933.CrossRefGoogle Scholar
Kumar, A.; Page, J. K.; and Spalt, O. G.. “Religious Beliefs, Gambling Attitudes, and Financial Market Outcomes.” Journal of Financial Economics, 102 (2011), 671–708.CrossRefGoogle Scholar
Lipson, M. L.; Mortal, S.; and Schill, M. J.. “On the Scope and Drivers of the Asset Growth Effect.” Journal of Financial and Quantitative Analysis, 46 (2011), 1651–1682.CrossRefGoogle Scholar
Merton, R. C.“An Intertemporal Capital Asset Pricing Model.” Econometrica, 41 (1973), 867–887.CrossRefGoogle Scholar
Merton, R. C.“On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29 (1974), 449–470.Google Scholar
Newey, W., and West, K.. “A Simple Positive Semi-Definite Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.CrossRefGoogle Scholar
Novy-Marx, R.“Operating Leverage.” Review of Finance, 15 (2011), 103–134.CrossRefGoogle Scholar
Novy-Marx, R. “The Other Side of Value: The Gross Profitability Premium.” Journal of Financial Economics, 108(2013), 1–28.CrossRefGoogle Scholar
Ohlson, J.“Financial Ratios and the Probabilistic Prediction of Bankruptcy.” Journal of Accounting Research, 18 (1980), 109–131.CrossRefGoogle Scholar
Pastor, L., and Stambaugh, R.. “Liquidity Risk and Stock Returns.” Journal of Political Economy, 111 (2003), 642–685.CrossRefGoogle Scholar
Scholes, M., and Williams, J.. “Estimating Betas from Nonsynchronous Data.” Journal of Financial Economics, 5 (1977), 309–327.CrossRefGoogle Scholar
Trigeorgis, L., and Lambertides, N.. “The Role of Growth Options in Explaining Stock Returns.” Journal of Financial and Quantitative Analysis, 49 (2014), 749–771.CrossRefGoogle Scholar
Van Zwet, W.“Convex Transformations: A New Approach to Skewness and Kurtosis.” Statistica Neerlandica, 18 (1964), 433–441.CrossRefGoogle Scholar
Vassalou, M., and Xing, Y.. “Default Risk in Equity Returns.” Journal of Finance, 59 (2004), 831–868.CrossRefGoogle Scholar
Xie, H.“The Mispricing of Abnormal Accruals.” Accounting Review, 76 (2001), 357–373.CrossRefGoogle Scholar
Xu, Y., and Malkiel, B. G.. “Investigating the Behavior of Idiosyncratic Volatility.” Journal of Business, 76 (2003), 613–645.CrossRefGoogle Scholar
Zhang, L.“The Value Premium.” Journal of Finance, 60 (2005), 67–103.CrossRefGoogle Scholar
Supplementary material: File

Bali et al. Supplementary Materials

Bali et al. Supplementary Materials

Download Bali et al. Supplementary Materials(File)
File 803.3 KB