Can Real Options Explain the Skewness of Stock Returns?

Tuan Ho, Kirak Kim, Yang Li and Fangming Xu

Journal of Banking & Finance, 2023, vol. 148, issue C

Abstract: We study a novel mechanism through which real options play a prominent role in inducing the skewness of stock returns. Building on the investment-based asset pricing framework, we show that firms’ real options to contract (expand) their businesses when productivity is low (high) can increase return skewness. Consequently, return skewness represents a U-shaped function of firm productivity. Furthermore, the real-options effect is stronger for more flexible firms, characterized by lower scale-adjustment frictions. Employing a large sample of U.S. firms during 1972–2018, we provide a battery of robust empirical evidence consistent with the model predictions. Our findings demonstrate that firm-level real flexibility can impact investors and managers’ decision making.

Keywords: Real options; Flexibility; Stock-return skewness (search for similar items in EconPapers)
JEL-codes: G12 G31 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:148:y:2023:i:c:s0378426622003314

DOI: 10.1016/j.jbankfin.2022.106751

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