The existing real options literature explains the value premium as a consequence of either operating leverage raising risk in low-demand states or industry-wide investment lowering risk in high-demand states. This paper presents a simple model in which a value premium arises solely from capacity...

Conventional wisdom, used to explain the value premium, is that greater operating leverage increases systematic risk and therefore leads to a higher expected rate of return earned by a firm's owners. This paper shows that the relationship between operating leverage and the expected return is...