Critical Finance Review > Vol 5 > Issue 1

Uncertainty and Valuations

Martijn Cremers, University of Notre Dame, USA, mcremers@nd.edu Hongjun Yan, DePaul University, USA, hongjun.yan.2011@gmail.com
 
Suggested Citation
Martijn Cremers and Hongjun Yan (2016), "Uncertainty and Valuations", Critical Finance Review: Vol. 5: No. 1, pp 85-128. http://dx.doi.org/10.1561/104.00000020

Published: 12 May 2016
© 2016 M. Cremers and H. Yan
 
Subjects
 
Keywords
G12
UncertaintyConvexityValuationTechnology bubble
 

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In this article:
1. Introduction
2. Hypotheses
3. Empirical Analysis
4. Conclusion
References

Abstract

Pastor and Veronesi (2003) proposed the idea that uncertainty about a firm’s profitability could increase its stock valuation, as an explanation for several phenomena in financial markets. We further examine this idea in a set-up with both stocks and bonds, and show that unless a firm is deeply in debt, the same logic implies that uncertainty increases a firm’s stock valuation but decreases its bond valuation, and that the uncertainty’s impact is stronger if the firm’s leverage is higher. Using a number of existing uncertainty proxies in the literature and controlling for volatility, we empirically test these predictions. Our evidence based on some (but not all) proxies supports the positive association between stock valuation and uncertainty. However, our evidence generally does not support the negative association between uncertainty and bond valuation using existing uncertainty proxies, particularly firm age. These results challenge the interpretation of the existing uncertainty proxies and thus the results in the literature employing them.

DOI:10.1561/104.00000020

Replication Data | 104.00000020_supp.zip (ZIP).

This file contains the data that is required to replicate the data on your own system. The SAS file shows how to calculate two of the uncertainty measures, ERC(1) and ERC(2), and the data.

DOI: 10.1561/104.00000020_supp