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Real Options, Idiosyncratic Skewness, and Diversification

Published online by Cambridge University Press:  08 February 2017

Luca Del Viva,
Eero Kasanen and
Lenos Trigeorgis
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Abstract

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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.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 52 , Issue 1 , February 2017, pp. 215 - 241
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

Footnotes

1 The authors thank an anonymous referee and Hendrik Bessembinder (the editor) for helpful comments. We gratefully acknowledge the financial support of Spanish Ministry of Education (Grant Number ECO2011-24928), Generalitat de Catalonia (Grant Number 2014-SGR-1079), Banc Sabadell, and the Jenny and Antti Wihuri Foundation.

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