Investigating the Effect of Real Options Resulting from Flexibility on Stock Return
Subject Areas : Financial Knowledge of Securities Analysismostafa Heidari Haratmeh 1 , Shamsollah Shirinbakhsh 2
1 - Faculty member of Islamic Azad University, Naragh Branch.
2 - Associate Professor, Department of Economics, Allameh Tabatabaei University.
Keywords: Real options, investment opportunities, flexibility, Panel - Data,
Abstract :
In this study, evidence is presented that shows the positive stock return-volatility relationship at the firm level is due to firm's real options. In the real options theory, it can be deduced:A) that the positive stock return-volatility at the firm level for those firms with more real options is much stronger and that the level of the sensitivity of the firm's stock return in response to the changes in the stock return volatility is significantly reduced due to the use of real options.B) that, the relationship between return – volatility for companies that have fewer restrictions and greater capabilities to better respond to uncertain demands (greater flexibility) are much stronger. In the real options models, managerial flexibility leads to greater firm's value convexity function . Thus, according to the theory of Jensen's inequality, sensitivity of the firm's value due to volatility in firm's underlying assets, while increasing, it should help to strengthen the company's flexibility to the changes in investment decisions and operations.
* Abraham, Katharine, and James Medoff, 1984, Length of service and layoffs in union and nonunion work groups, Industrial and Labor Relations Review 38, 87–97.
* Albuquerque, Rui, 2012, Skewness in stock returns: Reconciling the evidence on firm versus aggregate returns, Review of Financial Studies 25, 1630–1673.
* Amihud, Yakov, 2002, Illiquidity and stock returns: Cross-section and time-series effects, Journal of Financial Markets 5, 31–56.
* Andersen, Torben, Tim Bollerslev, and Francis Diebold, 2007, Roughing it up: Including jump components in measuring, modelling and forecasting asset return volatility, Review of Economics and Statistics 89, 701–120.
* Anderson, Christopher, and Luis Garcia-Feij´oo, 2006, Empirical evidence on capital investment, growth options, and security prices, Journal of Finance 61, 171–194.
* Ang, Andrew, Robert Hodrick, Yuhang Xing, and Xiaoyan Zhang, 2006, The cross-section of volatility and expected returns, Journal of Finance 61, 259–299.
* Ang, Andrew, RobertHodrick, Yuhang Xing, and Xiaoyan Zhang, 2009, High idiosyncratic volatility and low returns: International and further U.S. evidence, Journal of Financial Economics 91, 1–23.
* Baker, Malcolm, and Jeffrey Wurgler, 2006, Investor sentiment and the cross-section of stock returns, Journal of Finance 61, 1645–1680.
* Bandi, Federico, Claudia Moise, and Jeffrey Russell, 2008, The joint pricing of volatility and liquidity, Working paper, University of Chicago.
* Barber, Brad, and John Lyon, 1997, Detecting long-run abnormal stock returns: The empirical power and specification of test statistics, Journal of Financial Economics 43, 341–372.
* Barndorff-Nielsen, Ole, and Neil Shephard, 2004, Power and bipower variation with stochastic volatility and jumps, Journal of Financial Econometrics 2, 1–37.
* Barndorff-Nielsen, Ole, and Neil Shephard, 2006, Econometrics of testing for jumps in financial economics using bipower variation, Journal of Financial Econometrics 4, 1–30.
* Battalio, Robert, and Paul Schultz, 2006, Options and the bubble, Journal of Finance 61, 2071–2102.
* Berk, Jonathan, Richard Green, and Vasant Naik, 1999, Optimal investment, growth options, and security returns, Journal of Finance 54, 1553–1607.
* Bernard, Victor, and Jacob Thomas, 1989, Post-earnings announcement drift: Delayed price response or risk premium, Journal of Accounting Research 27, 1–35.
* Bernardo, Antonio, and Bhagwan Chowdhry, 2002, Resources, real options, and corporate strategy, Journal of Financial Economics 63, 211–234.
* Black, Fischer, 1976, Studies of stock price volatility changes, in proceedings of the Business and Economic Statistics Section, American Statistics Association.
* Bollen, Nicolas, 1999, Real options and product life cycles, Management Science 45, 670–684.
* Brandt, Michael, Runeet Kishore, Pedro Santa-Clara, and Mohan Venkatachalam, 2009, Earnings announcements are full of surprises, Working paper, Duke University.
* Brennan, Michael, and Eduardo Schwartz, 1985, Evaluating natural resource investments, Journal of Business 58, 135–157.
* Brown, Gregory, and Nishad Kapadia, 2007, Firm-specific risk and equity market development, Journal of Financial Economics 84, 358–388.
* Bulan, Laarni, 2005, Real options, irreversible investment and firm uncertainty: New evidence from U.S. firms, Review of Financial Economics 14, 255–279.
* Caballero, Ricardo, and Robert Pindyck, 1992, Uncertainty, investment, and industry evolution, Working paper, MIT.
* Campbell, John, and Ludger Hentschel, 1992, No news is good news: An asymmetric model of changing volatility in stock returns, Journal of Financial Economics 31, 281–318.
* Campbell, John, Martin Lettau, Burton Malkiel, and Yexiao Xu, 2001, Have individual stocks become more volatile? An empirical exploration of idiosyncratic risk, Journal of Finance 56, 1–44.
* Cao, Charles, Timothy Simin, and Jing Zhao, 2008, Can growth options explain the trend in idiosyncratic risk? Review of Financial Studies 21, 2599–2633.
* Carlson, Murray, Adlai Fisher, and Ron Giammarino, 2004, Corporate investment and asset price dynamics: Implications for the cross-section of returns, Journal of Finance 59, 2577–2603.
* Carlson, Murray, Adlai Fisher, and Ron Giammarino, 2006, Corporate investment and asset price dynamics: Implications for SEO event studies and long-run performance, Journal of Finance 61, 1009–1034.
* Carlson, Murray, Adlai Fisher, and Ron Giammarino, 2010, SEO risk dynamics, Review of Financial Studies 23, 4026–4077.
* Carlson,Murray, ZeighamKhokher, and Sheridan Titman, 2007, Equilibrium exhaustible resource price dynamics, Journal of Finance 62, 1663–1703.
* Chemmanur, Thomas, Shan He, and Debarshi Nandy, 2010, The going public decision and the product market, Review of Financial Studies 23, 1855–1908.
* Chen, Jason, Marcin Kasperczyk, and Hernan Ortiz-Molina, 2011, Labor unions, operating flexibility, and the cost of equity, Journal of Financial and Quantitative Analysis 46, 25–58.
* Christie, Andrew, 1982, The stochastic behavior of common stock variances: Value, leverage and interest rate effects, Journal of Financial Economics 10, 407–432.
* Cooper, Michael, Huseyin Gulen, and Michael Schill, 2008, Asset growth and the cross-section of stock returns, Journal of Finance 63, 1609–1652.
* Da, Zhi, Re Guo, and Ravi Jagannathan, 2012, CAPM for estimating the cost of equity capital: Interpreting the empirical evidence, Journal of Financial Economics 103, 204–220.
* Duffee, Gregory, 1995, Stock return and volatility. A firm-level analysis, Journal of Financial Economics 37, 399–420.
* Duffee, Gregory, 2002, Balance sheet explanations for asymmetric volatility, Working paper, University of California.
* Fama, Eugene, and Kenneth French, 1993, Common risk factors in the returns of stocks and bonds, Journal of Financial Economics 33, 3–56.
* Fama, Eugene, andKenneth French, 1997, Industry costs of equity, Journal of Financial Economics 49, 153–193.
* Fama, Eugene, and James MacBeth, 1973, Risk, return, and equilibrium: Empirical tests, Journal of Political Economy 81, 607–636.
* Fan, Ying, and Lei Zhu, 2010, A real options-based model and its application to China’s overseas oil investment decisions, Energy Economics 32, 627–637.
* Frazzini, Andrea, and Owen Lamont, 2007, The earnings announcement premium and trading volume, Working paper, University of Chicago.
* French, Kenneth, William Schwert, and Robert Stambaugh, 1987, Expected stock returns and volatility, Journal of Financial Economics 19, 3–29.
* Galai, Dan, and Ronald Masulis, 1976, The option pricing model and the risk factor of stock, Journal of Financial Economics 3, 53–81.
* Ghosal, Vivek, 1991, Demand uncertainty and the capital-labor ratio: Evidence from the U.S. manufacturing sector, Review of Economics and Statistics 73, 157–161.
* Gibbons, Michael, Stephen Ross, and Jay Shanken, 1989, The test of the efficiency of a given portfolio, Econometrica 57, 1121–1152.
* Gramm, Cynthia, and John Schnell, 2001, The use of flexible staffing arrangements in core production jobs, Industrial and Labor Relations Review 54, 245–268.
* Griffin, John, Jeffrey Harris, Tao Shu, and Selim Topaloglu, 2011, Who drove and burst the tech bubble? Journal of Finance 66, 1251–1290.
* Guiso, Luigi, and Giuseppe Parigi, 1999, Investment and demand uncertainty, Quarterly Journal of Economics 114, 185–227.
* Gustavo Grullon, Evgeny Lyandres, and Alexei Zhdanov, 2012, Real Options, Volatility, and Stock Returns, The Journal Of Finance , 4 , 1498-1537.
* Hirsh, Barry, and David Macpherson, 2003, Union membership and coverage database from the current population survey: Note, Industrial and Labor Relations Review 56, 349–354.
* Jegadeesh, Narasimhan, and Sheridan Titman, 1993, Returns to buying winners and selling losers: Implications for stock market efficiency, Journal of Finance 48, 65–91.
* Joos, Philip, and Alexei Zhdanov, 2008, Earnings and equity valuation in the biotech industry: Theory and evidence, Financial Management 37, 431–459.
* Kapadia, Nishad, 2007, The next Microsoft? Skewness, idiosyncratic volatility, and expected returns, Working paper, Rice University.
* Karpoff, Jonathan, 1987, The relation between price changes and trading volume: A survey, Journal of Financial and Quantitative Analysis 22, 109–126.
* Leahy, John, and Toni Whited, 1996, The effect of uncertainty on investment: Some stylized facts, Journal of Money, Credit, and Banking 28, 64–83.
* Lemmon, Michael, and Jaime Zender, 2010, Debt capacity and tests of capital structure theories, Journal of Financial and Quantitative Analysis 45, 1161–1187.
* Loughran, Tim, and Jay Ritter, 1995, The new issues puzzle, Journal of Finance 50, 23–51.
* Lyandres, Evgeny, Le Sun, and Lu Zhang, 2008, The new issues puzzle: Testing the investmentbased explanation, Review of Financial Studies 21, 2825–2855.
* Lyon, John, Brad Barber, and Chih-Ling Tsai, 1999, Improved methods for tests of long-run abnormal stock returns, Journal of Finance 54, 165-201.
* Majd, Saman, and Robert Pindyck, 1987, Time to build, option value, and investment decisions, Journal of Financial Economics 18, 7–27.
* Marschak, Thomas, and Richard Nelson, 1962, Flexibility, uncertainty, and economic theory, International Review of Economics 14, 42–58.
* McDonald, Robert, and Daniel Siegel, 1985, Investment and valuation of firms when there is an option to shut down, International Economic Review 26, 331–349.
* McDonald, Robert, and Daniel Siegel, 1986, The value of waiting to invest, Quarterly Journal of Economics 101, 707–727.
* Mills, David, 1984, Demand fluctuations and endogenous firm flexibility, Journal of Industrial Economics 33, 55–71.
* Moel, Alberto, and Peter Tufano, 2002, When are real options exercised? An empirical study of mine closings, Review of Financial Studies 15, 35–64.
* Newey, Whitney, and KennethWest, 1987, A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix, Econometrica 55, 703–708.
* Oi, Walter, 1961, The desirability of price instability under perfect competition, Econometrica 29, 58–64.
* Ottoo, Richard, 1998, Valuation of internal growth opportunities: The case of a biotechnology company, Quarterly Review of Economics and Finance 38, 615–633.
* Paddock, James, Daniel Siegel, and James Smith, 1988, Option valuation of claims on real assets: The case of offshore petroleum leases, Quarterly Journal of Economics 103, 479–508.
* Petersen, Mitchell, 2009, Estimating standard errors in finance panel data sets: Comparing approaches, Review of Financial Studies 22, 435–480.
* Pindyck, Robert, 1988, Irreversible investment, capacity choice, and the value of the firm, American Economic Review 78, 969–985.
* Pindyck, Robert, 1993, A note on competitive investment under uncertainty, American Economic Review 83, 273–277.
* Ritter, Jay, 2003, Investment banking and security issuance, in George Constantinides, Milton Harris, and Ren´e Stulz, eds.: Handbook of Economics and Finance (North Holland, Amsterdam).
* Scheinkman, Jos´e, and Wei Xiong, 2003, Overconfidence and speculative bubbles, Journal of Political Economy 111, 1183–1219.
* Schultz, Paul, 2008, Downward-sloping demand curves, the supply of shares, and the collapse of internet stock prices, Journal of Finance 63, 351–378.
* Stigler, George, 1939, Production and distribution in the short run, Journal of Political Economy 47, 305–327.
* Veronesi, Pietro, 1999, Stock market overreactions to bad news in good times: A rational expectations equilibrium model, Review of Financial Studies 12, 975–1007.
* Whited, Toni, 2006, External finance constraints and the intertemporal pattern of intermittent investment, Journal of Financial Economics 81, 467–502.
* Xing, Yuhang, 2008, Interpreting the value effect through the Q-theory: An empirical investigation, Review of Financial Studies 21, 1767–1795.
_||_
