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A novel equity valuation and capital allocation model for use by long-term value-investors

Myuran Rajaratnam, Bala Rajaratnam and Kanshukan Rajaratnam

Journal of Banking & Finance, 2014, vol. 49, issue C, 483-494

Abstract: We present a novel asset pricing model that captures the investment wisdom and stock-selection approach of the long-term value-investors Benjamin Graham and Warren Buffett. Taking a longer term view of business prospects and business risks, we explicitly consider the time period in which a business enjoys a competitive advantage over its peers as the central tenet of our model and capture the eventual demise of this competitive advantage in a probabilistic manner. Assuming that our investor has log utility, our model answers the question of capital allocation in a two-asset scenario. The model does not enforce the Efficient Market Hypothesis and is shown to explain some well-known empirical studies on stock returns.

Keywords: Equities; Asset pricing; Asset returns; Value-investing; Capital allocation (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1016/j.jbankfin.2014.02.014

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Handle: RePEc:eee:jbfina:v:49:y:2014:i:c:p:483-494