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The Valuation of a Firm Advertising Optimally

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  • D. Epstein
  • N.Mayor
  • P.Schonbucher
  • A.E. Whalley
  • P. Wilmott

Abstract

In this paper we model the value of a firm based on its current earnings and cash balances. The value is modelled on the assumption that earnings follow a mean-reverting process. The effect of advertising on earnings is modelled, and the condition for optimal advertising derived. The value of the firm is derived as the solution to a partial differential equation. The way in which this value depends on the legal structure and banking arrangements of the firm is discussed.

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Bibliographic Info

Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 1999mf01.

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Date of creation: 1999
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Handle: RePEc:sbs:wpsefe:1999mf01

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Web page: http://www.finance.ox.ac.uk
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  1. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
  2. Duffie, J Darrell & Huang, Chi-fu, 1985. "Implementing Arrow-Debreu Equilibria by Continuous Trading of Few Long-lived Securities," Econometrica, Econometric Society, vol. 53(6), pages 1337-56, November.
  3. Andrew B. Abel & Avinash K. Dixit & Janice C. Eberly & Robert S. Pindyck, 1995. "Options, the Value of Capital, and Investment," NBER Working Papers 5227, National Bureau of Economic Research, Inc.
  4. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
  5. Cooper, Ian A & Mello, Antonio S, 1991. " The Default Risk of Swaps," Journal of Finance, American Finance Association, vol. 46(2), pages 597-620, June.
  6. Milne, Alistair & Robertson, Donald, 1996. "Firm behaviour under the threat of liquidation," Journal of Economic Dynamics and Control, Elsevier, vol. 20(8), pages 1427-1449, August.
  7. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  8. McDonald, Robert L & Siegel, Daniel R, 1985. "Investment and the Valuation of Firms When There Is an Option to Shut Down," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 331-49, June.
  9. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
  10. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
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Cited by:
  1. Steven Li, 2003. "A valuation model for firms with stochastic earnings," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(3), pages 229-243.
  2. Lander, Diane M. & Pinches, George E., 1998. "Challenges to the Practical Implementation of Modeling and Valuing Real Options," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 537-567.
  3. Christian-Oliver Ewald & Zhaojun Yang, 2008. "Utility based pricing and exercising of real options under geometric mean reversion and risk aversion toward idiosyncratic risk," Computational Statistics, Springer, vol. 68(1), pages 97-123, August.
  4. Steven Li, 2002. "A valuation model for firms with stochastic earnings," School of Economics and Finance Discussion Papers and Working Papers Series 122, School of Economics and Finance, Queensland University of Technology.

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