Academic journal article Journal of the Association for Information Systems

Measuring Risk from IT Initiatives Using Implied Volatility

Academic journal article Journal of the Association for Information Systems

Measuring Risk from IT Initiatives Using Implied Volatility

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1Introduction

Risky choices are hard to gauge, and few choices affect firms' risk more than new information technology (IT) initiatives. As IT continues to be a major driving force for innovation, productivity, and economic growth, IT projects are becoming increasingly complex and IT capabilities are often difficult to build and manage. According to an IBM study, nearly 60% of IT projects do not meet schedule, budget, and quality goals (Jorgensen, Owen, & Neus, 2008). A more recent survey shows that more than 50% of firms had an IT project that failed during the previous year (Innotas, 2013).

Adopting the definition for IT risk from Dewan, Shi, and Gurbaxani (2007), "the ex-ante uncertainty associated with IT returns" (p. 1829), we propose an important and underrecognized measure of firm risk that allows researchers to explore the relationship between IT investments and both short- and long-term firm risk. Implied volatility (IV) of a firm's exchangetraded options is a unique measure of firm risk that can be used to study changes that result from specific events. IV is obtained from a priced stock option and represents the option market's expectation of the underlying firm's average stock return volatility over the remaining duration of the option contract (Merton, 1973; Donders & Vorst, 1996). Thus, by construction, IV is the expected uncertainty about the underlying firm value by the market (Rogers, Douglas, & Van Buskirk, 2009).

The IS discipline has long been interested in information systems-related risks such as userperceived risk (e.g., Pavlou & Gefen, 2004; Nicolaou & McKnight, 2006), investor perceived risk (e.g., Dewan & Ren, 2007; Kim, Mithas, & Kimbrough, 2017), security risk (e.g., Loch, Carr, & Warkentin, 1992), IT project risk (e.g., Alter & Ginzberg, 1978; Kwon, 1987; Benaroch, 2002), software risk (e.g., Charette, 1989; Boehm, 1991; Fairley, 1994; Tian & Xu, 2015), and business process risk (e.g., Kettinger, Teng, & Guha, 1997; Kliem, 2000). By design, these risk measures are at the user level, project level, business process level, etc.

Assessing changes in firm risk from IT is difficult. Prior work is equivocal about whether IT investment announcements (hereafter "IT announcements") or planned IT investments should decrease or increase firm risk and is silent regarding their short- versus long-term effects on firm risk. On the one hand, IT enhances information processing and thus enables firms to better respond to demand and task uncertainties (Galbraith, 1974); on the other hand, IT assets are inherently risky to build and manage (Wang & Alam, 2007).

An example of IT's complex impact on firm-level risk is investments in digitally controlled machines in manufacturing. These machines can easily produce related but different products, whereas nondigital machines are more limited in scope or have large changeover costs. Digitally controlled machines can switch between products at low cost, based on demand fluctuations, making the firm more agile and reducing the uncertainty of future cash flows, thus reducing firm risk. On the other hand, to make the best use of digitally controlled machines, they must be integrated into the existing production environment, may necessitate the redesign of existing business processes, and require training, all of which increase firm risk.

Employed as the expected uncertainty about underlying firm value, IV as a measure of IT-induced firm risk has three advantages. First, it is forward looking and market driven. As IV is derived from the price of a traded option, it is based on option market investors' estimates of future stock return volatility. In other words, it is risk that is perceived about a firm's future on a particular date by investors. Thus, IV is a market-derived consensus from a set of experts based on their future expectations.

Second, being derived from the option price means that IV does not directly rely on historical stock price volatility, the alternative market-based measure of risk. …

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