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Are equities real(ly) options? Understanding the size, book-to-market and earnings-to-price factors

Pope, P F and Stark, A W (1999) Are equities real(ly) options? Understanding the size, book-to-market and earnings-to-price factors. Working Paper. The Department of Accounting and Finance, Lancaster University.

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    Abstract

    We model the value of a firm facing irreversible investment opportunities as a portfolio of real call options: options to invest and options to produce. Theory predicts that the expected return on the firm s equity is dependent on (i) the CAPM beta of the assets underlying the options; and (ii) the average elasticity of the options. The average option elasticity depends on volatility, the level of demand and the degree of excess capacity. Our analysis, based on a large scale simulation experiment, confirms these predictions. Additionally we show that the factors analyzed by Fama and French (1992) - beginning-of-period market value of equity, book-to-market equity and earnings-to-price - are strongly associated with the CAPM beta of the underlying assets, volatility, the level of demand and the degree of excess capacity. The links to (unobservable) model fundamentals provide a clear economic rationale for the Fama and French risk factors, but they do not require an appeal to the pricing of bankruptcy risk.

    Item Type: Monograph (Working Paper)
    Subjects:
    Departments: Lancaster University Management School > Accounting & Finance
    ID Code: 48586
    Deposited By: ep_importer_pure
    Deposited On: 11 Jul 2011 22:01
    Refereed?: No
    Published?: Published
    Last Modified: 27 Jul 2012 01:10
    Identification Number:
    URI: http://eprints.lancs.ac.uk/id/eprint/48586

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