Growth Options, Equity Risk and Returns: Evidence from Pharmaceutical and Biotechnology Firms
Posted: 11 Jun 2015 Last revised: 6 Apr 2022
Date Written: Novermber 1 2015 ,
Abstract
Real options models predict that the creation and exercise of growth options are important determinants of firm equity risk and expected returns. This paper tests these predictions by examining risk and return dynamics around approvals of highly-innovative drugs and awards of patents underlying these drugs. Both events are associated with significant short and medium-term increases in stock prices, the magnitude of which is positively related to the value of embedded growth options. The systematic and idiosyncratic risk increases following patent awards and the idiosyncratic risk decreases following drug approvals. However, equity risk changes are not systematically related to subsequent stock prices changes.
Keywords: Real Options, Expected Returns, Dynamic Risk, Idiosyncratic Risk, Announcement Effects
JEL Classification: G31, G32
Suggested Citation: Suggested Citation