Living with Noise: Investing and Valuation in the Face of Uncertainty
34 Pages Posted: 20 Sep 2013
Date Written: July 10, 2013
Uncertainty is a fact of life in business and investing, but the responses that analysts and investors have to uncertainty is often unhealthy, ranging from denial and paralysis, at one extreme, to rules of thumb that have no basis in common sense, at the other. In this paper, we look at how uncertainty is embedded in all valuations, though the amount of uncertainty you face will vary across companies, countries and across time. We categorize uncertainty into groups, estimation versus economic, micro versus macro and discrete versus continuous, and argue that each grouping needs a different response. Finally, we develop tools that we can use to get a handle on uncertainty and deal with it better in valuation.
Keywords: valuation, risk, uncertainty
JEL Classification: G10, G12, G30
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