Uncertainty in Firm Valuation and a Cross-Sectional Misvaluation Measure

38 Pages Posted: 25 Jun 2020 Last revised: 2 Jul 2020

See all articles by Giulio Bottazzi

Giulio Bottazzi

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM)

Francesco Cordoni

University of Pisa - Department of Economics and Management

Giulia Livieri

Scuola Normale Superiore

Stefano Marmi

Scuola Normale Superiore

Date Written: May 31, 2020

Abstract

In all investment decisions it is important to determine the degree of uncertainty associated with the valuation of a company. We propose an original and robust methodology to company valuation which replaces the traditional point estimate of the conventional Discounted Cash Flow (DCF) with a probability distribution of fair values. It hinges on two main ingredients: an econometric model for the company revenues and a set of firm-specific balance sheet relations that are estimated using historical data. The effectiveness and scope of our methodology are explored through a series of statistical exercises on publicly traded U.S. companies. We show that an uncertainty-adjusted indicator of mispricing, derived from the fair value distribution, is capable of predicting future abnormal returns. Then, we construct a new long-short valuation factor and we test that it is not redundant for describing average returns when used to augment traditional market factor models.

Keywords: Stochastic Discounted Cash Flow, Valuation Uncertainty, Valuation Factor, Kalman Filter.

JEL Classification: G11, G17, G32.

Suggested Citation

Bottazzi, Giulio and Cordoni, Francesco and Livieri, Giulia and Marmi, Stefano, Uncertainty in Firm Valuation and a Cross-Sectional Misvaluation Measure (May 31, 2020). Available at SSRN: https://ssrn.com/abstract=3614988 or http://dx.doi.org/10.2139/ssrn.3614988

Giulio Bottazzi

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM) ( email )

Piazza Martiri della Liberta, 33
Pisa, I-56127
Italy
+39-050-883343 (Phone)
+39-050-883344 (Fax)

Francesco Cordoni (Contact Author)

University of Pisa - Department of Economics and Management ( email )

Italy

Giulia Livieri

Scuola Normale Superiore ( email )

Piazza dei Cavalieri, 7
Pisa, 56126
Italy

Stefano Marmi

Scuola Normale Superiore ( email )

Piazza dei Cavalieri, 7
Pisa, 56126
Italy
+39050509064 (Phone)
+39050563513 (Fax)

HOME PAGE: http://homepage.sns.it/marmi/

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