Investment Options, Assets in Place, and the Risk of Stocks

This paper employs contingent claims analysis to decompose the firm's systematic risk into the risk as- sociated with its assets in place and the risk arising from future growth opportunities. 5 Contingent claims analysis is well-suited to such decomposition, since a growth opportunity can be regarded as a call option on a real asset where the option's exercise price is the fu- ture investment needed to acquire the asset. Whether the option has any value at expiration depends on the asset's future value. In essence, this study predicts that the greater the portion of a stock's market value ac- counted for by the firm's growth opportunities, the higher the stock risk. Overall, our empirical results strongly support this hypothesis