TY - JOUR
T1 - Implied Mortality for the Firm: The Market Tells the Tail
JF - The Journal of Portfolio Management
SP - 122
LP - 134
DO - 10.3905/jpm.2020.1.199
VL - 47
IS - 3
AU - Copeland, Maggie
AU - Copeland, Thomas
AU - Song, Koda
Y1 - 2021/01/31
UR - http://jpm.pm-research.com/content/47/3/122.abstract
N2 - Traditional valuation models such as the Gordon growth model, the discounted cash flow (DCF) model, and the real option approach assume that cash flows are perpetual. There is no firm that lasts forever. In the expected time to ruin model, the underlying firm has an expected termination date. In an efficient market, stock prices should reflect all available information. Adapted from a revised valuation model, the authors solve for the implied mortality (IM) of an underlying firm given its equity market price. The authors investigate IM for securities during the last few crises. The existence of IM may be the missing piece of the unexplained volatility puzzle.TOPICS: Financial crises and financial market history, exchange-traded funds and applications, security analysis and valuation, tail risksKey Findings▪ Most valuation models of the firm assume that cash flows are perpetual. Of course, this is incorrect. By applying the Expected Time to Ruin Model, we solve for the Implied Mortality (IM) of an underlying firm given its equity market price.▪ IM would be a useful and easy tool for the credit market trading. High leverage firms such as those in the financial industry suffered more during the crisis. We investigate the last three crises and different degrees of impact on them.▪ The change in IM may be the missing piece of the unexplained volatility puzzle or so-called “Irrational Exuberance.”
ER -