Real Options, Volatility, and Stock Returns

Theoretical models predict that the value of a real option should be increasing in the volatility ofthe underlying asset. Thus, if real options are economically important, then firm values should bepositively related to volatility. Consistent with this prediction, we find evidence that stock returnsare contemporaneously positively correlated with changes in volatility. Moreover, this positiverelation is stronger for firms that are more likely to have more real options and for firms with moreirreversible investment opportunities.[...]