The Impact of Volatility on Firms Holding Growth Options

Abstract

“Abuses of real option valuation were partly behind the ramping and subsequent deramping of the 2000 internet techno bubble. No one ever got to eat the free lunch these real option 'theorists' promised. No one ever will; no one ever could.” (Mayor 2001, 53) Growth options contribute to over 95% of the market value of Internet stocks such as Amazon.com, America Online, and eBay. Finance theory often promotes market volatility as being desirable for investors holding financial options. Is volatility also desirable for firms holding growth options? While many argue that it is, this paper presents a simple example illustrating that increasing volatility can destroy growth option value, especially for firms holding “quality” growth options.