An Aggregation Theorem for the Valuation of Equity Under Linear Information Dynamics

DJ Ashton, T Cooke, M Tippett

Research output: Contribution to journalArticle (Academic Journal)peer-review

21 Citations (Scopus)

Abstract

We state an Aggregation Theorem which shows that the recursion value of equity is functionally proportional to its adaptation value. Since the recursion value of equity is equal to its book value plus the expected present value of its abnormal earnings, it follows that the adaptation value of equity can normally be determined by a process of simple quadrature. We demonstrate the application of the Aggregation Theorem using two stochastic processes. The first uses the linear information dynamics of the Ohlson (1995) model. The second uses linear information dynamics based on the Cox, Ingersoll and Ross (1985)'square root' process. Both these processes lead to closed form expressions for the adaptation and overall market value of equity. There are, however, many other processes which are compatible with the Aggregation Theorem. These all show that the market value of equity will be a highly convex function of its recursion value. The empirical evidence we report for UK companies largely supports the convexity hypothesis.
Translated title of the contributionAn Aggregation Theorem for the Valuation of Equity Under Linear Information Dynamics
Original languageEnglish
Pages (from-to)413 - 440
Number of pages28
JournalJournal of Business Finance and Accounting
Volume30 (3-4)
DOIs
Publication statusPublished - Apr 2003

Bibliographical note

Publisher: Blackwell

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