The author gratefully acknowledges helpful comments from two anonymous referees.
REAL OPTIONS AND THE CROSS-SECTION OF EXPECTED STOCK RETURNS
Article first published online: 18 FEB 2013
© 2013 John Wiley & Sons Ltd
Journal of Economic Surveys
Volume 28, Issue 2, pages 265–283, April 2014
How to Cite
Guthrie, G. (2014), REAL OPTIONS AND THE CROSS-SECTION OF EXPECTED STOCK RETURNS. Journal of Economic Surveys, 28: 265–283. doi: 10.1111/joes.12011
- Issue published online: 12 MAR 2014
- Article first published online: 18 FEB 2013
- Expected stock returns;
- Real options;
- Value premium
This paper surveys the theoretical literature investigating the effect of firms’ investment flexibility on the cross-section of expected stock returns. Real options analysis derives firms’ value-maximizing investment policies as functions of exogenous fundamental drivers of profitability and calculates firms’ market values as functions of the same variables. These functions yield the relationship between expected stock returns and firm fundamentals. Several plausible explanations for the value premium – the high average stock returns earned by firms with high book-to-market ratios – emerge from this literature.