We propose to measure growth opportunities by firms' exposure to idiosyncratic volatility news. Theoretically, we show that the value of a growth option increases in idiosyncratic volatility but its response to volatility of aggregate shocks can be either positive or negative depending on option moneyness. Empirically, we show that price sensitivity to variation in idiosyncratic volatility carries significant information about firms' future investment and growth even after controlling for conventional proxies of growth options such as bookto-market and other relevant firm characteristics. Consistent with our theoretical arguments, we also find that firm' exposure to aggregate volatility, while priced, does not help predict their future growth. Option-intensive firms identified using our idiosyncratic volatility-based measure earn a lower premium than do firms that rely more heavily on assets in place.
Bibliographical noteFunding Information:
The authors thank Ravi Bansal, Andres Donangelo, Laurent Fresard, Pete Kyle, Howard Kung, Bradley Paye, and Yajun Wang, as well as seminar participants at Duke University, Temple University, the University of Texas at Dallas, the University of Maryland, the University of Illinois at Urbana-Champaign, the University of Utah, the University of Houston, INSEAD, the 2013 Society for Financial Studies Finance Cavalcade, the 2014 Arizona State University Sonoran Winter Finance Conference, the 2014 Finance Down Under Conference, and the 2014 Western Finance Association meetings for their helpful comments. The authors also thank Jerome Detemple (department editor), an associate editor, and a referee for their insightful comments. The usual disclaimer applies.
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- Asset pricing
- Growth options
- Idiosyncratic volatility