The Role of Growth Options in Explaining Stock Returns

Lenos Trigeorgis and Neophytos Lambertides

Journal of Financial and Quantitative Analysis, 2014, vol. 49, issue 3, 749-771

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.

Date: 2014
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