Hostname: page-component-78c5997874-mlc7c Total loading time: 0 Render date: 2024-11-15T07:11:48.480Z Has data issue: false hasContentIssue false
  • English
  • Français

The Role of Growth Options in Explaining Stock Returns

Published online by Cambridge University Press:  26 February 2014

Lenos Trigeorgis  and
Neophytos Lambertides
Lenos Trigeorgis
Affiliation:
lenos@ucy.ac.cy, Faculty of Economics and Management, University of Cyprus, PO Box 20537, Nicosia, CY 1678, Cyprus
Neophytos Lambertides
Affiliation:
n.lambertides@cut.ac.cy, Department of Commerce, Finance, and Shipping, Cyprus University of Technology, 115 Spyrou Araouzou St, Lemesos, 3036, Cyprus.
Get access Rights & Permissions [Opens in a new window]

Abstract

We extend the Fama-French (1992) model by considering growth option (as well as distress/leverage) variables in explaining the cross section of stock returns. We find that growth option variables, namely growth in capital investment and yet-unexercised growth options (GO), are significantly and negatively related to stock returns. Investors may be willing to accept lower average returns from growth stocks in exchange for a more favorable (positively skewed) risk-return profile. Book-to-market (BM) ratio seems to proxy for omitted distress/leverage variables. When these are explicitly accounted for, BM is not that significant. Our growth options variables have added explanatory power.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 49 , Issue 3 , June 2014 , pp. 749 - 771
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2014 

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.)

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.Google Scholar
Anderson, W. C., and Garcia-Feijoo, L.. “Empirical Evidence on Capital Investment, Growth Options, and Security Returns.” Journal of Finance, 61 (2006), 171–194.Google Scholar
Berk, J. B.; Green, R. C.; and Naik, V.. “Optimal Investment, Growth Options, and Security Returns.” Journal of Finance, 54 (1999), 1553–1607.Google Scholar
Bhandari, L. C. “Debt/Equity Ratio and Expected Common Stock Returns: Empirical Evidence.” Journal of Finance, 43 (1988), 507–528.CrossRefGoogle Scholar
Brown, S.; Lajbcygier, P.; and Li, B.. “Going Negative: What to Do with Negative Book Equity Stocks.” Journal of Portfolio Management, 35 (2008), 95–102.Google 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.Google Scholar
Carlson, M.; Fischer, A.; and Giammarino, R.. “Corporate Investment and Asset Price Dynamics: Implications of the Cross-Section of Returns.” Journal of Finance, 59 (2004), 2577–2603.Google Scholar
Chan, L. K. C., and Lakonishok, J.. “Are the Reports of Beta’s Death Premature?” Journal of Portfolio Management, 19 (1993), 51–62.Google Scholar
Chen, H. J. “What Does the Value Premium Tell Us About the Term Structure of Equity Returns?” Working Paper, University of British Columbia (2011).Google Scholar
Chen, L.; Novy-Marx, R.; and Zhang, L.. “An Alternative Three-Factor Model.” Working Paper, Washington University, University of Chicago, and Ohio State University (2011).Google Scholar
Chung, Y. P., and Schill, M. J.. “Asset Pricing When Returns Are Non-Normal: Fama-French Factors vs. Higher-Order Systematic Co-Moments.” Journal of Business, 79 (2006), 923–940.Google Scholar
Cochrane, J. H. “Production-Based Asset Pricing and the Link Between Stock Returns and Economic Fluctuations.” Journal of Finance, 46 (1991), 209–237.Google Scholar
Conrad, J.; Dittmar, R. F.; and Ghysels, E.. “Ex-Ante Skewness and Expected Stock Returns.” Journal of Finance, 68 (2013), 85–124.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
Dittmar, R. F. “Non-Linear Pricing Kernels, Kurtosis Preference, and Evidence from the Cross-Section of Equity Returns.” Journal of Finance, 57 (2002), 369–403.CrossRefGoogle Scholar
Doukas, J. A.; Kim, C. F.; and Pantzalis, C.. “A Test of the Error-in-Expectations Explanation of the Value/Glamour Stock Returns Performance: Evidence from Analysts’ Forecasts.” Journal of Finance, 57 (2002), 2143–2165.Google Scholar
Fama, E., and French, K.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–466.Google Scholar
Fama, E., and French, K.. “Common Risk Factors in the Returns on Stock and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.Google Scholar
Fama, E., and French, K.. “Dissecting Anomalies.” Journal of Finance, 63 (2008), 1653–1678.Google Scholar
Fama, E., and MacBeth, J.. “Risk, Return and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607–636.Google Scholar
Garleanu, N.; Kogan, L.; and Panageas, S.. “Displacement Risk and Asset Returns.” Journal of Financial Economics, 105 (2012), 491–510.Google Scholar
Garleanu, N.; Panageas, S.; and Yu, J.. “Technological Growth and Asset Pricing.” Journal of Finance, 67 (2012), 1265–1292.Google Scholar
Grullon, G.; Lyandres, E.; and Zhdanov, A.. “Real Options, Volatility, and Stock Returns.” Journal of Finance, 67 (2012), 1499–1537.Google Scholar
Gomes, J.; Kogan, L.; and Zhang, L.. “Equilibrium Cross-Section of Returns.” Journal of Political Economy, 81 (2003), 607–636.Google Scholar
Harvey, C. R., and Siddique, A.. “Conditional Skewness in Asset Pricing Tests.” Journal of Finance, 55 (2000), 1263–1295.Google Scholar
Kester, W. C. “Today’s Options for Tomorrow’s Growth.” Harvard Business Review, March–April (1984), 153–160.Google Scholar
Knez, P. J., and Ready, M. J.. “On the Robustness of Size and Book-to-Market in Cross-Sectional Regressions.” Journal of Finance, 52 (1997), 1355–1382.Google Scholar
Lakonishok, J.; Shleifer, A.; and Vishny, R. W.. “Contrarian Investment, Extrapolation and Risk.” Journal of Finance, 49 (1994), 1541–1578.Google Scholar
Lamont, O. A. “Investment Plans and Stock Returns.” Journal of Finance, 55 (2000), 2719–2745.Google Scholar
Li, Q.; Vassalou, M.; and Xing, Y.. “Sector Investment Growth Rates and the Cross-Section of Returns.” Journal of Business, 79 (2006), 1637–1636.Google Scholar
Lintner, J. “The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets.” Review of Economics and Statistics, 47 (1965), 13–37.Google 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.Google Scholar
Myers, S. C. “Determinants of Corporate Borrowing.” Journal of Financial Economics, 5 (1977), 147–175.Google Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.Google Scholar
Shanken, J. “On the Estimation of Beta-Pricing Models.” Review of Financial Studies, 5 (1992), 1–55.Google Scholar
Sharpe, W. F. “Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk.” Journal of Finance, 19 (1964), 425–442.Google Scholar
Smit, J. T. J., and Trigeorgis, L.. Strategic Investment. Princeton, NJ: Princeton University Press (2004).CrossRefGoogle Scholar
Titman, S.; Wei, K. C. J.; and Xie, F.. “Capital Investment and Stock Returns.” Journal of Financial and Quantitative Analysis, 39 (2004), 677–700.Google Scholar
Trigeorgis, L. Real Options. Cambridge, MA: MIT Press (1996).Google Scholar
Xie, H. “The Mispricing of Abnormal Accruals.” Accounting Review, 76 (2001), 357–373.Google Scholar
Xu, Y., and Malkiel, B. G.. “Investigating the Behavior of Idiosyncratic Volatility.” Journal of Business, 76 (2003), 613–644.Google Scholar