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Diversification in Firm Valuation: A Multivariate Copula Approach

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Author Info

  • Stefan Erdorf

    ()
    (University of Cologne)

  • Thomas Hartmann-Wendels

    (University of Cologne)

  • Nicolas Heinrichs

    ()
    (University of Cologne)

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    Abstract

    We introduce a new discounted cash flow model which adopts the diversification effect of multi-business firms. We face two challenges: One is examining how different diversification extents can affect the firm value due to risk reduction, and the other is modeling segment-specific cash flows and discount rates to reflect the differences in risk and growth characteristics across the different businesses that a firm operates in. Since the co-movement of business segments depends on the state of the economy, we use a multivariate copula approach taking the state-varying dependence of business segments explicitly into account. A high level of a firm's diversification determined by a low dependence between the firm's business segments leads to a lower probability of firm default which results in a higher firm value through reduced bankruptcy costs. We demonstrate this effect by comparing the values of three U.S. firms when modeling independence, dependence with copulas, and perfect dependence between businesses.

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    Bibliographic Info

    Paper provided by Cologne Graduate School in Management, Economics and Social Sciences in its series Cologne Graduate School Working Paper Series with number 02-01.

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    Date of creation: Jan 2011
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    Handle: RePEc:cgr:cgsser:02-01

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    Related research

    Keywords: diversification; firm valuation; dependence modeling; multi-business firm; bankruptcy costs; default probability; copulas; Monte Carlo simulation; discounted cash flow model;

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    Cited by:
    1. Stefan Erdorf & Nicolas Heinrichs, 2011. "Co-movement of revenue: structural changes in the business cycle," Financial Markets and Portfolio Management, Springer, vol. 25(4), pages 411-433, December.

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