Essays on Real Options and Tail Risks

Student thesis: Doctoral ThesisDoctor of Philosophy (PhD)


This thesis investigates the relevance of real options to corporate shareholders in three aspects, as presented in three self-contained chapters as follows. Chapter 2 studies 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. Chapter 3 demonstrates that contraction options help reduce crash risk. This effect is stronger for firms with lower productivity, lower profitability or higher operating leverage. Using U.S. data between 1962 and 2019, we find strong empirical evidence supporting the model’s predictions. Our work suggests that firms’ investment and operation decisions affect their stock price crash risk without appealing to more widely recognized information asymmetry arguments in the crash risk literature. Chapter 4 shows that real flexibility curbs losses in firm value and reduces return volatility, especially for firms with high book-to-market or high COVID-19 exposure, consistent with the idea that the benefits of real flexibility are associated primarily with contraction options, rather than expansion options, during the COVID-19 crisis. Our analysis shows that real flexibility provides incremental and complementary protection beyond financial flexibility. Besides its impact on stock prices, real flexibility also helps firms sustain earnings, especially during 2020 compared with 2019 when the pandemic had not struck. Our work demonstrates that real flexibility is an important tool for corporate managers in navigating episodes of disasters.
Date of Award24 Jan 2023
Original languageEnglish
Awarding Institution
  • University of Bristol
SupervisorTuan Q Ho (Supervisor) & Fangming Xu (Supervisor)

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