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Diversification in Firm Valuation: A Multivariate Copula Approach

Listed author(s):
  • Stefan Erdorf


    (University of Cologne)

  • Thomas Hartmann-Wendels

    (University of Cologne)

  • Nicolas Heinrichs


    (University of Cologne)

Registered author(s):

    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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    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
    Handle: RePEc:cgr:cgsser:02-01
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