Real options and asymmetric volatility in light of the firm’s growth opportunities

ABSTRACT

This study proposes a real options exercise mechanism as a novel explanation for the asymmetric volatility phenomenon. We suggest that asymmetric volatility stems from the exercise of real call options following positive shocks and the exercise of real put options after negative shocks. Furthermore, we uniquely link asymmetric volatility to real options and firm’s growth opportunities. Using US market return data from the period spanning 1926–2018, this paper demonstrates that following a positive market shock generating return volatility, growth-firms exercise more real call options than value-firms. This further alleviates growth-firms’ volatility response, thereby resulting in higher asymmetric volatility. Book-to-market portfolio analyses provide significant empirical evidence that the firm’s growth opportunities intensify the asymmetric volatility phenomenon.

KEYWORDS:

• Asymmetric volatility
• market returns
• book-to-market
• growth opportunities

JEL CLASSIFICATION:

• G12
• G17
• C22
• C58

Acknowledgements

We thank Ilan Cooper, Doron Avramov, Simon Benninga, and Avi Wohl for their helpful comments. We also thank seminar participants from the Hebrew University of Jerusalem, Tel Aviv University, Ariel University, the 26th annual meeting of the European Financial Management Association (EFMA) 2017 in Athens, Greece, and the World Finance Conference 2017 in Sardinia, Italy. Financial support from the Rosenfeld Foundation is gratefully acknowledged. Any remaining mistakes are our own.

Notes

1 We examine the short-term asymmetric volatility definition, e.g., see Lönnbark (2017), considering return-volatility reactions to market shocks.

2 For example, the binomial model (Cox, Ross, & Rubinstein, 1979) shows that a call option is actually a leveraged buy position of stocks, hence acquiring call options’ increased volatility. Lehnert (2019) shows the change in options’ implied volatility resulting from mutual-funds inflows. Sayed and Auret (2019) illustrate volatility spillover between future markets to other financial instruments’ markets.

3 Kim, Ryu, and Yang (2019) find asymmetric responses of investors between upgrade and downgrade news; Nasr, Balcilar, Gupta, and Saint Akadiri (2019) find asymmetric effects of income inequality information on the GDP level.

4 http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.

5 We start in 1964 because Fama-French (1992) mention that prior to 1963 the COMPUSTAT data is biased.