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The Role of Growth Options in Explaining Stock Returns

Published online by Cambridge University Press:  26 February 2014

Lenos Trigeorgis  and
Neophytos Lambertides
Lenos Trigeorgis
Affiliation:
lenos@ucy.ac.cy, Faculty of Economics and Management, University of Cyprus, PO Box 20537, Nicosia, CY 1678, Cyprus
Neophytos Lambertides
Affiliation:
n.lambertides@cut.ac.cy, Department of Commerce, Finance, and Shipping, Cyprus University of Technology, 115 Spyrou Araouzou St, Lemesos, 3036, Cyprus.
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Abstract

We extend the Fama-French (1992) model by considering growth option (as well as distress/leverage) variables in explaining the cross section of stock returns. We find that growth option variables, namely growth in capital investment and yet-unexercised growth options (GO), are significantly and negatively related to stock returns. Investors may be willing to accept lower average returns from growth stocks in exchange for a more favorable (positively skewed) risk-return profile. Book-to-market (BM) ratio seems to proxy for omitted distress/leverage variables. When these are explicitly accounted for, BM is not that significant. Our growth options variables have added explanatory power.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 49 , Issue 3 , June 2014 , pp. 749 - 771
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2014 

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