Uncertainty and Valuations
University of Notre Dame
Yale University - International Center for Finance
September 5, 2012
Yale ICF Working Paper No. 09-06
The idea that uncertainty about a firm’s profitability could increase its stock valuation has been proposed by Pastor and Veronesi (2003) to explain several phenomena in financial markets. We further examine this idea in a setup with both stocks and bonds, and show that unless a firm is deeply in debt, the same logic implies that uncertainty increases its stock valuation but decreases its bond valuation, and that the uncertainty’s impact is stronger if the firm’s leverage is higher. Using a number of existing uncertainty proxies in the literature and controlling for volatility, we empirically test these predictions. Our evidence based on some (but not all) proxies supports the positive association between stock valuation and uncertainty. However, our evidence generally does not support the negative association between uncertainty and bond valuations using existing uncertainty proxies, particularly firm age. These results challenge the interpretation of the existing uncertainty proxies and thus the results in the literature employing them.
Number of Pages in PDF File: 41
Keywords: Uncertainty, convexity, valuation, technology bubble
JEL Classification: G12
Date posted: March 23, 2009 ; Last revised: September 6, 2012
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