Real Options, Volatility, and Stock Returns





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    • Gustavo Grullon is with the Jesse H. Jones Graduate School of Business, Rice Univerisity. Evgeny Lyandres is with the School of Management, Boston University. Alexei Zhdanov is with the University of Lausanne and Swiss Finance Institute. The authors thank Rui Abuquerque, Yakov Amihud, Doron Avramov, Clifford Ball, Alexander Barinov, Jonathan Berk, Gennaro Bernile, Nicolas Bollen, Jacob Boudoukh, Tim Burch, Murray Carlson, Lauren Cohen, François Degeorge, Darrell Duffie, Rafi Eldor, Wayne Ferson, Amit Goyal, Dirk Hackbarth, Campbell Harvey (the Editor), Ohad Kadan, Markku Kaustia, Matti Keloharju, Timo Korkeamaki, Moshe Levy, Lubomir Litov, Hong Liu, Roni Michaely, Barb Ostdiek, Dino Palazzo, Brad Paye, Neil Pearson, Gordon Phillips, Lukasz Pomorski, Amir Rubin, Jacob Sagi, Dan Segal, Anjan Thakor, Yuri Tserlukevich, Masahiro Watanabe, James Weston, Zvi Wiener, Yuhang Xing, Guofu Zhou, an Associate Editor, an anonymous referee, and seminar participants at Aalto School of Economics, Hebrew University, Interdisciplinary Center Herzliya, Louisiana State University, Rice University, Texas A&M International University, Vanderbilt University, Washington University at Saint Louis, University of Illinois at Urbana-Champaign, University of Miami, University of Texas at San Antonio, 2008 University of British Columbia Winter Finance Conference, 2008 Rotschild Caesarea Center Conference, 2008 European Finance Association Meetings, 2011 Finance Down Under Conference, and 2011 Napa Valley Conference for helpful comments and suggestions. The authors also thank Hernan Ortiz-Molina for help with using union membership data and Sarah Diez for valuable research assistance.


We provide evidence that the positive relation between firm-level stock returns and firm-level return volatility is due to firms’ real options. Consistent with real option theory, we find that the positive volatility-return relation is much stronger for firms with more real options and that the sensitivity of firm value to changes in volatility declines significantly after firms exercise their real options. We reconcile the evidence at the aggregate and firm levels by showing that the negative relation at the aggregate level may be due to aggregate market conditions that simultaneously affect both market returns and return volatility.