Capital Investment and Variance Risk Premia


We document that the variance risk premium in asset returns decreases firms' investments. We theoretically model the premium; we find that it increases the value of the real option to delay an investment and, thus, influences investments negatively. Empirically, we verify the negative link between the variance risk premium and investments. Cross-sectionally, the link is more important for investment-grade firms, which have relatively higher exposure to systematic variance risk. This premium helps us understand an otherwise surprising pattern investments are lower for investment-grade firms with better investment conditions than speculative-grade. Investment-grade firms basically hedge variance risk by delaying investment.

Working Paper