Real Options

Question 1

Da, Guo and Jagannathan 2012

Answer 1

• Because stocks are backed not only by projects in place, but also by the options to modify current projects and undertake new ones, the expected returns on stocks need not satisfy the CAPM even when expected returns of projects do.
• provide empirical support for our arguments by developing a method for estimating firms’ project CAPM betas and project returns.
• findings justify the continued use of the CAPM by firms in spite of the mounting evidence against it based on the cross section of stock returns.

Question 2

Grullon, Lyandres and Zhdanov 2012

Answer 2

• Consistent with real option theory
• 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.
• 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.

Question 3

Wu, Zhang and Zhang 2010

Answer 3

• Accrual anomaly can be explained by the Q-theory
• Accruals are working capital investment
• Firms optimally adjust their investment in response to discount rate changes
• A higher discount rate means less profitable investments and lower accruals
• A lower discount rate results in more profitable investments and higher accruals

Question 4

Cao, Simin and Zhao 2008

Answer 4

• The firm’s idiosyncratic risk has increased over time (Campbell, et al 2001, JF)
• an explanation for this trend remains elusive.
• This paper shows that
• the upward trend in idiosyncratic risk can be explained by
• changes in the level and variance of growth options.
• Accounting for growth options eliminates or reverses the trend in aggregate firm-specific risk over last four decades