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Idiosyncratic volatility, growth options, and the cross-section of returns

Author

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  • Barinov, Alexander
  • Chabakauri, Georgy

Abstract

The value effect and the idiosyncratic volatility (IVol) discount arise because growth firms and high IVol firms beat the CAPM during periods of increasing aggregate volatility (market volatility and average IVol), that makes their risk low. All else equal, growth options' value increases with volatility, an effect that is stronger for high IVol firms, for which growth options take a larger fraction of the firm value and firm volatility responds more to aggregate volatility changes. The factor model with the market factor, the market volatility risk factor, and the average IVol factor explains the value effect and the IVol discount.

Suggested Citation

  • Barinov, Alexander & Chabakauri, Georgy, 2023. "Idiosyncratic volatility, growth options, and the cross-section of returns," LSE Research Online Documents on Economics 120814, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:120814
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    File URL: http://eprints.lse.ac.uk/120814/
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    Keywords

    Paul Woolley Centre;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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