Uncertainty in firm valuation and a cross-sectional misvaluation measure

Giulio Bottazzi, Francesco Cordoni (), Giulia Livieri () and Stefano Marmi ()
Additional contact information
Francesco Cordoni: Royal Holloway University of London
Giulia Livieri: London School of Economics and Political Science, Columbia House
Stefano Marmi: Scuola Normale Superiore

Annals of Finance, 2023, vol. 19, issue 1, No 3, 63-93

Abstract: Abstract The degree of uncertainty associated with the value of a company plays a relevant role in valuation analysis. We propose an original and robust methodology for company market valuation, which replaces the traditional point estimate of the conventional Discounted Cash Flow model with a probability distribution of fair values that convey information about both the expected value of the company and its intrinsic uncertainty. Our methodology depends on two main ingredients: an econometric model for company revenues and a set of firm-specific balance sheet relations that are estimated using historical data. We explore the effectiveness and scope of our methodology through a series of statistical exercises on publicly traded U.S. companies. At the firm level, we show that the fair value distribution derived with our methodology constitutes a reliable predictor of the company’s future abnormal returns. At the market level, we show that a long-short valuation (LSV) factor, built using buy-sell recommendations based on the fair value distribution, contains information not accessible through the traditional market factors. The LSV factor significantly increases the explanatory and the predictive power of factor models estimated on portfolios and individual stock returns.

Keywords: Stochastic discounted cash flow; Valuation uncertainty; Valuation factor; Kalman filter (search for similar items in EconPapers)
JEL-codes: G11 G17 G32 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://link.springer.com/10.1007/s10436-022-00423-w Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Uncertainty in firm valuation and a cross-sectional misvaluation measure (2023)
Working Paper: Uncertainty in Firm Valuation and a Cross-Sectional Misvaluation Measure (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:annfin:v:19:y:2023:i:1:d:10.1007_s10436-022-00423-w

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/10436/PS2

DOI: 10.1007/s10436-022-00423-w

Access Statistics for this article

Annals of Finance is currently edited by Anne Villamil

More articles in Annals of Finance from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().