Can real options explain the skewness of stock returns?

Tuan Ho, Kirak Kim, Yang Li, Fangming Xu

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We study a novel mechanism through which real options play a prominent role in inducing the skewness of stock returns. Building on the investment-based asset pricing framework, we show that firms’ real options to contract (expand) their businesses when productivity is low (high) can increase return skewness. Consequently, return skewness represents a U-shaped function of firm productivity. Furthermore, the real-options effect is stronger for more flexible firms, characterized by lower scale-adjustment frictions. Employing a large sample of U.S. firms during 1972–2018, we provide a battery of robust empirical evidence consistent with the model predictions. Our findings demonstrate that firm-level real flexibility can impact investors and managers’ decision making.

Original languageEnglish
Article number106751
Number of pages12
JournalJournal of Banking & Finance
Early online date22 Dec 2022
Publication statusPublished - Mar 2023


  • Real options
  • Flexibility
  • Stock-return skewness


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