A Bayesian Framework for Combining Valuation Estimates

Yee, Kenton K.
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Obtaining more accurate equity value estimates is the starting point for stock selection, value-based indexing in a noisy market, and beating benchmark indices through tactical style rotation. Unfortunately, discounted cash flow, method of comparables, and fundamental analysis typically yield discrepant valuation estimates. Moreover, the valuation estimates typically disagree with market price. Can one form a superior valuation estimate by averaging over the individual estimates, including market price? This article suggests a Bayesian framework for combining two or more estimates into a superior valuation estimate. The framework justifies the common practice of averaging over several estimates to arrive at a final point estimate.
Comment: Citations at http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=240309 Review of Quantitative Finance and Accounting, 30.3 (2008) forthcoming
Quantitative Finance - Statistical Finance, Computer Science - Computational Engineering, Finance, and Science, Nonlinear Sciences - Adaptation and Self-Organizing Systems, Nonlinear Sciences - Chaotic Dynamics, Nonlinear Sciences - Exactly Solvable and Integrable Systems, Physics - Popular Physics, Physics - Physics and Society, Statistics - Applications