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Growth options and firm valuation

Author

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  • Kraft, Holger
  • Schwartz, Eduardo
  • Weiss, Farina

Abstract

This paper studies the relation between firm value and a firm's growth options. We find strong empirical evidence that (average) Tobin's Q increases with firm-level volatility. However, the significance mainly comes from R&D firms, which have more growth options than non-R&D firms. By decomposing firm-level volatility into its systematic and unsystematic part, we also document that only idiosyncratic volatility (ivol) has a significant effect on valuation. Second, we analyze the relation of stock returns to realized contemporaneous idiosyncratic volatility and R&D expenses. Single sorting according to the size of idiosyncratic volatility, we only find a significant ivol anomaly for non-R&D portfolios, whereas in a four-factor model the portfolio alphas of R&D portfolios are all positive. Double sorting on idiosyncratic volatility and R&D expenses also reveals these differences between R&D and non-R&D firms. To simultane-ously control for several explanatory variables, we also run panel regressions of portfolio alphas which confirm the relative importance of idiosyncratic volatility that is amplified by R&D expenses.

Suggested Citation

  • Kraft, Holger & Schwartz, Eduardo & Weiss, Farina, 2013. "Growth options and firm valuation," SAFE Working Paper Series 6, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
  • Handle: RePEc:zbw:safewp:6
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. N. Bloom., 2016. "Fluctuations in uncertainty," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 4.
    2. Samaniego, Roberto & Sun, Juliana, 2016. "Gray's Anatomy: Understanding Uncertainty," MPRA Paper 72787, University Library of Munich, Germany.
    3. Suzuki, Kazuyuki & Chida, Ryokichi, 2017. "Contribution of R&D capital to differences in Tobin's q among Japanese manufacturing firms: Evidence from an investment-based asset pricing model," Journal of the Japanese and International Economies, Elsevier, vol. 43(C), pages 38-58.
    4. Binding, Garret & Dibiasi, Andreas, 2017. "Exchange rate uncertainty and firm investment plans evidence from Swiss survey data," Journal of Macroeconomics, Elsevier, vol. 51(C), pages 1-27.

    More about this item

    Keywords

    Firm valuation; Real options; Volatility; R&D expenses;

    JEL classification:

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

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