Diversification in Firm Valuation: A Multivariate Copula Approach
AbstractWe 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 InfoPaper provided by Cologne Graduate School in Management, Economics and Social Sciences in its series Cologne Graduate School Working Paper Series with number 02-01.
Date of creation: Jan 2011
Date of revision:
diversification; firm valuation; dependence modeling; multi-business firm; bankruptcy costs; default probability; copulas; Monte Carlo simulation; discounted cash flow model;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
- L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
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- 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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