Volatility Risks and Growth Options

We propose to measure growth opportunities by firms’ exposure to idiosyncratic volatility news. Theoretically, we show that the value of a growth option increases in idiosyncratic volatility but its response to volatility of aggregate shocks can be either positive or negative depending on option mon...

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Bibliographic Details
Published inManagement science Vol. 62; no. 3; pp. 741 - 763
Main Authors Ai, Hengjie, Kiku, Dana
Format Journal Article
LanguageEnglish
Published Linthicum INFORMS 01.03.2016
Institute for Operations Research and the Management Sciences
Subjects
asset pricing
Business enterprises
Business growth
Companies
Corporate management
Economic research
finance
Financial performance
Growth
growth options
idiosyncratic volatility
Management
Methods
News
Risk assessment
Volatility
Volatility (Finance)
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Summary:We propose to measure growth opportunities by firms’ exposure to idiosyncratic volatility news. Theoretically, we show that the value of a growth option increases in idiosyncratic volatility but its response to volatility of aggregate shocks can be either positive or negative depending on option moneyness. Empirically, we show that price sensitivity to variation in idiosyncratic volatility carries significant information about firms’ future investment and growth even after controlling for conventional proxies of growth options such as book-to-market and other relevant firm characteristics. Consistent with our theoretical arguments, we also find that firm’ exposure to aggregate volatility, while priced, does not help predict their future growth. Option-intensive firms identified using our idiosyncratic volatility-based measure earn a lower premium than do firms that rely more heavily on assets in place. This paper was accepted by Jerome Detemple, finance.
ISSN:0025-1909
1526-5501
DOI:10.1287/mnsc.2014.2129