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Growth to value: Option exercise and the cross section of equity returns, Working Paper (2012)
| Citations: | 21 - 1 self |
BibTeX
@MISC{Ai12growthto,
author = {Hengjie Ai and Dana Kiku},
title = {Growth to value: Option exercise and the cross section of equity returns, Working Paper},
year = {2012}
}
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Abstract
We put forward an equilibrium model that provides a link between the cross section of expected returns and book-to-market characteristics. We model two primitive assets: value assets, and growth assets that are options on assets in place. The cost of option exercise, which is endogenously determined in equilibrium, is highly procyclical and acts as a hedge against risks in assets in place. Consequently, growth options are less risky than value assets, and the model features a value premium. Our model incorporates long-run risks in aggregate consumption (as in Bansal and Yaron (2004)) and replicates the empirical failure of the conditional CAPM prediction. We calibrate the model and show that it is able to quantitatively account for the observed pattern in mean returns on book-to-market sorted portfolios, the magnitude of the CAPM-alphas, and other silent features of the cross-sectional data.
Keyphrases
option exercise cross section equity return value asset value premium cross-sectional data observed pattern equilibrium model silent feature long-run risk conditional capm prediction mean return growth asset primitive asset growth option empirical failure aggregate consumption book-to-market characteristic
