Stocks with high idiosyncratic volatility perform poorly relative to low idiosyncratic volatility stocks. We offer a novel explanation of this anomaly based on real options, which is consistent with earlier findings on idiosyncratic volatility (the positive contemporaneous relation between...

The real options theory suggests that firm value should include the value of real options, i.e., a firm has the option to expand a more profitable business and the option to liquidate assets of a less profitable business. For a diversified firm, each segment has similar options. Applying the...

We use a stochastic frontier model to obtain a stock-level estimate of the difference between a firm's installed production capacity and its optimal capacity. We show that this “capacity overhang” estimate relates significantly negatively to the cross-section of stock returns, even when...

This paper surveys the theoretical literature investigating the effect of firms' investment flexibility on the cross-section of expected stock returns. Real options analysis derives firms' value-maximizing investment policies as functions of exogenous fundamental drivers of profitability and...

Theory suggests that firm value should include the value of real options; that is, firms have the option to expand more profitable businesses and liquidate less profitable businesses. In a diversified firm, each segment has its own real options. Applying real options theory to a diversified firm...

Are options on more volatile assets expected to provide higher or lower return? Using analytics, we show the ambiguous nature of the answer when the volatility differential is due to the systematic/priced risk. Here the difference in the expected return of the assets also matters and has an...

An anchoring-adjusted option pricing model is developed in which the volatility of the underlying stock return is used as a starting point that gets adjusted upwards to form expectations about call option volatility. I show that the anchoring price lies within the bounds implied by risk-averse...

Constantinides et al (2013) put forward a number of empirical findings regarding leverage adjusted S&P 500 index option returns. Their findings are puzzling in the context of the Black-Scholes-Merton Option Pricing Model and the Capital Asset Pricing Model. Experimental evidence as well as the...

I show that the inventory risk faced by market-makers has a first-order effect on option prices. I introduce a simple approach that decomposes the price impact of trades into inventory risk and asymmetric information components. While both components are large for option trades, the inventory...

We develop an ex-ante measure of expected stock returns based on analyst price targets. We then show that ex-ante measures of volatility, skewness, and kurtosis implied from stock option prices are positively related to the cross section of ex-ante expected stock returns. While expected returns...