Department of Economics and Business Economics

Conservatism in Corporate Valuation

Research output: Working paperResearch

Standard

Conservatism in Corporate Valuation. / Bach, Christian.

Aarhus : Institut for Økonomi, Aarhus Universitet, 2011.

Research output: Working paperResearch

Harvard

Bach, C 2011 'Conservatism in Corporate Valuation' Institut for Økonomi, Aarhus Universitet, Aarhus.

APA

Bach, C. (2011). Conservatism in Corporate Valuation. Aarhus: Institut for Økonomi, Aarhus Universitet.

CBE

Bach C. 2011. Conservatism in Corporate Valuation. Aarhus: Institut for Økonomi, Aarhus Universitet.

MLA

Bach, Christian Conservatism in Corporate Valuation. Aarhus: Institut for Økonomi, Aarhus Universitet. 2011., 66 p.

Vancouver

Bach C. Conservatism in Corporate Valuation. Aarhus: Institut for Økonomi, Aarhus Universitet. 2011.

Author

Bach, Christian. / Conservatism in Corporate Valuation. Aarhus : Institut for Økonomi, Aarhus Universitet, 2011.

Bibtex

@techreport{73f94442db8a465f9636d57ab05e72fd,
title = "Conservatism in Corporate Valuation",
abstract = "Using a CCAPM based risk adjustment model, consistent with general asset pricing theory, I perform corporate valuations of a large sample of stocks listed on NYSE, AMEX and NASDAQ. The model is different from the standard CAPM model in the sense that it discounts forecasted residual income for risk in the numerator rather than trough the cost of equity, in the denominator. Further, the risk adjustment is based on assumptions about the time series properties of residual income return and consumption rather than historical returns. I compare the pricing performance of the model with the standard CAPM based valuation model, both considering the absolute valuation errors and an investment setting where simple investment strategies are made based on the results of the respective models. The CCAPM model performs substantially better than the CAPM based model when comparing absolute valuation errors. Both models are able to explain abnormal returns impressively well, when constructing investment strategies, but also in this setting the CCAPM model outperforms the CAPM model in most dimensions.I further show that the standard CAPM and the Fama-French 3 factor based approaches to risk adjustment substantially overestimate the cost of risk. This {"}error{"} more than offsets yet another {"}error{"}, committed when using analyst's forecasts of long-term growth which are 3-4 times higher than what can be considered reasonable. Using the CCAPM approach to valuation, the results imply that investors are very conservative in their valuation of long-term value generation and very conservative in risk adjusting future value generation.",
keywords = "Accounting beta, corporate valuation, Compustat, cost of capital, covariance risk, CRSP, I/B/E/S, residual income, risk adjusted discounting, CAPM, CCAPM",
author = "Christian Bach",
year = "2011",
language = "English",
publisher = "Institut for {\O}konomi, Aarhus Universitet",
type = "WorkingPaper",
institution = "Institut for {\O}konomi, Aarhus Universitet",

}

RIS

TY - UNPB

T1 - Conservatism in Corporate Valuation

AU - Bach, Christian

PY - 2011

Y1 - 2011

N2 - Using a CCAPM based risk adjustment model, consistent with general asset pricing theory, I perform corporate valuations of a large sample of stocks listed on NYSE, AMEX and NASDAQ. The model is different from the standard CAPM model in the sense that it discounts forecasted residual income for risk in the numerator rather than trough the cost of equity, in the denominator. Further, the risk adjustment is based on assumptions about the time series properties of residual income return and consumption rather than historical returns. I compare the pricing performance of the model with the standard CAPM based valuation model, both considering the absolute valuation errors and an investment setting where simple investment strategies are made based on the results of the respective models. The CCAPM model performs substantially better than the CAPM based model when comparing absolute valuation errors. Both models are able to explain abnormal returns impressively well, when constructing investment strategies, but also in this setting the CCAPM model outperforms the CAPM model in most dimensions.I further show that the standard CAPM and the Fama-French 3 factor based approaches to risk adjustment substantially overestimate the cost of risk. This "error" more than offsets yet another "error", committed when using analyst's forecasts of long-term growth which are 3-4 times higher than what can be considered reasonable. Using the CCAPM approach to valuation, the results imply that investors are very conservative in their valuation of long-term value generation and very conservative in risk adjusting future value generation.

AB - Using a CCAPM based risk adjustment model, consistent with general asset pricing theory, I perform corporate valuations of a large sample of stocks listed on NYSE, AMEX and NASDAQ. The model is different from the standard CAPM model in the sense that it discounts forecasted residual income for risk in the numerator rather than trough the cost of equity, in the denominator. Further, the risk adjustment is based on assumptions about the time series properties of residual income return and consumption rather than historical returns. I compare the pricing performance of the model with the standard CAPM based valuation model, both considering the absolute valuation errors and an investment setting where simple investment strategies are made based on the results of the respective models. The CCAPM model performs substantially better than the CAPM based model when comparing absolute valuation errors. Both models are able to explain abnormal returns impressively well, when constructing investment strategies, but also in this setting the CCAPM model outperforms the CAPM model in most dimensions.I further show that the standard CAPM and the Fama-French 3 factor based approaches to risk adjustment substantially overestimate the cost of risk. This "error" more than offsets yet another "error", committed when using analyst's forecasts of long-term growth which are 3-4 times higher than what can be considered reasonable. Using the CCAPM approach to valuation, the results imply that investors are very conservative in their valuation of long-term value generation and very conservative in risk adjusting future value generation.

KW - Accounting beta, corporate valuation, Compustat, cost of capital, covariance risk, CRSP, I/B/E/S, residual income, risk adjusted discounting, CAPM, CCAPM

M3 - Working paper

BT - Conservatism in Corporate Valuation

PB - Institut for Økonomi, Aarhus Universitet

CY - Aarhus

ER -