Growth to value: Option exercise and the cross section of equity returns

Hengjie Ai, Dana Kiku

Research output: Contribution to journalArticlepeer-review


We propose a general equilibrium model to study the link between the cross section of expected returns and book-to-market characteristics. We model two primitive assets: value assets and growth assets that are options on assets in place. The cost of option exercise, which is endogenously determined in equilibrium, is highly procyclical and acts as a hedge against risks in assets in place. Consequently, growth options are less risky than value assets, and the model features a value premium. Our model incorporates long-run risks in aggregate consumption and replicates the empirical failure of the conditional capital asset pricing model (CAPM) prediction. The model also quantitatively accounts for the pattern in mean returns on book-to-market sorted portfolios, the magnitude of the CAPM-alphas, and other stylized features of the cross-sectional data.

Original languageEnglish (US)
Pages (from-to)325-349
Number of pages25
JournalJournal of Financial Economics
Issue number2
StatePublished - Feb 2013
Externally publishedYes


  • Firm dynamics
  • General equilibrium
  • Long-run risks
  • Real options
  • Value premium

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management


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