Articlebronze2017

Real Options, Idiosyncratic Skewness, and Diversification

Luca Del Viva · Eero Kasanen · Lenos G Trigeorgis

47 citations0/0 files storedJournal of Financial and Quantitative Analysis

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Financial Markets and Investment Strategies Stochastic processes and financial applications Capital Investment and Risk Analysis

Abstract

We show how firm-level real options lead to idiosyncratic skewness in stock returns. We then document empirically that growth option variables are positive and significant determinants of idiosyncratic skewness. The real option impact on skewness is more significant in firms with lottery-type features, small size, high volatility, distressed, low return on assets, and low book-to-market ratio. We also find that expectation on idiosyncratic skewness is associated with lower Sharpe ratios. This suggests investors are willing to sacrifice mean-variance portfolio efficiency for greater skewness deriving from real options. Furthermore, financial flexibility has a positive incremental effect, enhancing the beneficial role of asset flexibility on idiosyncratic skewness.

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References

1991Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations 1973The Pricing of Options and Corporate Liabilities 1993Common risk factors in the returns on stocks and bonds 1998Initial conditions and moment restrictions in dynamic panel data models 1995Another look at the instrumental variable estimation of error-components models 1995Initial conditions and moment restrictions in dynamic panel data models 2008Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches 1981Biases in Dynamic Models with Fixed Effects

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