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...

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...

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...

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...

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...

This paper studies the returns from investing in index options. Previous research documents significant average option returns, large CAPM alphas, and high Sharpe ratios, and concludes that put options are mispriced. We propose an alternative approach to evaluate the significance of option...

Traditional plain vanilla options can be regarded as options on a simple return. These options have convex payoffs and as a consequence of Jensen's inequality, their prices are increasing as a function of maturity in the absence of interest rate. This makes long dated call options as excessively...

Due to their short lifespans and migrating moneyness, options are notoriously difficult to study with the factor models commonly used to analyze the risk-return tradeoff in other asset classes. In-trumented principal components analysis (IPCA) solves this problem by tracking contracts in terms...

We study the relation between option-implied skewness (IS) and the cross-section of option returns under daily hedging to better understand the pricing of skewness in isolation from lower moments. Creating portfolios of delta-hedged (D-hedged) and delta-vega-hedged (DV-hedged) options with daily...

We present a new finding that the return autocorrelation of underlying stock is an important determinant of expected equity option returns. Using an extended Black-Scholes model incorporating the presence of stock return autocorrelation, we show that expected returns of both call and put options...