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Valuing Financial Service Firms

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Valuing banks, insurance companies and investment banks has always been difficult, but the rolling market crises of the last few years has elevated the concern to the top of the list of valuation issues. The problems with valuing financial service firm stem from two key characteristics. The first is that the cash flows to a financial service firm cannot be easily estimated, since many of the ingredients needed are not clearly defined. The second is that most financial service firms operate under a regulatory framework that governs how they are capitalized, where they invest and how fast they can grow. Changes in the regulatory environment can create large shifts in value. In this paper, we confront both factors. We develop a simple model to value banks and us it to extract the two key numbers that drive the value of a bank. The first is the cost of equity, which will be a function of the risk that emanates from the firm’s investments, and second is the return on equity, which is determined both by the company’s investment choices as well as regulatory restrictions.

Suggested Citation

  • Damodaran, Aswath, 2013. "Valuing Financial Service Firms," Journal of Financial Perspectives, EY Global FS Institute, vol. 1(1), pages 59-74.
  • Handle: RePEc:ris:jofipe:0001
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    Keywords

    banks; valuation; financial service firms;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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