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Market dynamics when participants rely on relative valuation

Author

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  • Lavelle, Sean

Abstract

Relative-valuation is a technique whereby financial analysts estimate the value of an asset by comparing it to its peers. The author formalizes the decision-making structure of a relativevaluation strategy and simulate a market defined by its use. He finds that when the distribution of peer valuation-multiples is skewed high or low, the market will tend to equilibrate over or undervalued, respectively. He furthers this analysis by looking at the effect that subjective analyst adjustments of market multiples might have and concludes that they have the potential to be highly destabilizing.

Suggested Citation

  • Lavelle, Sean, 2016. "Market dynamics when participants rely on relative valuation," Economics Discussion Papers 2016-42, Kiel Institute for the World Economy (IfW Kiel).
    • Handle: RePEc:zbw:ifwedp:201642
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    References listed on IDEAS

    as
    1. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
    2. Da, Zhi & Schaumburg, Ernst, 2011. "Relative valuation and analyst target price forecasts," Journal of Financial Markets, Elsevier, vol. 14(1), pages 161-192, February.
    3. Alford, Aw, 1992. "The Effect Of The Set Of Comparable Firms On The Accuracy Of The Price Earnings Valuation Method," Journal of Accounting Research, Wiley Blackwell, vol. 30(1), pages 94-108.
    4. Jing Liu & Doron Nissim & Jacob Thomas, 2002. "Equity Valuation Using Multiples," Journal of Accounting Research, Wiley Blackwell, vol. 40(1), pages 135-172, March.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Relative valuation; inefficient; EMH; simulation; comparative valuation;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets

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