Todd Mitton and Keith Vorkink from (boring) BYU published Why Do Firms With Diversification Discounts Have Higher Expected Returns? Their answer: no skew. People will pay up for lottery tickets, but if you take those dreams away, it becomes an asset that is neglected. They find diversified firms offers less skew, and diversification discounts are significantly greater when the diversified firm offers less
skewness than typical focused firms in similar business segments. They suggest a
substantial proportion of the excess returns received on discount firms relative to premium
firms can be explained by differences in exposure to skewness.
The implication is clear: people pay a premium for volatile stocks that have stories and potential. Conditional upon playing in a risky game, such as equities, there's not a return premium for risk, there's a premium for boring.
The implication is clear: people pay a premium for volatile stocks that have stories and potential. Conditional upon playing in a risky game, such as equities, there's not a return premium for risk, there's a premium for boring.
1 comment:
Hmm, it's behind a paywall - but this seems to be a weaker explanation than the more obvious one: The discount is there because the market is worried that management doesn't really know what they are doing in each industry, and may be incentivized to grow the size of the company for their benefit at the expense of shareholders. And the market overprices this discount.
And this would be entirely consistent with skewness being related to how diversified the firms actually are.
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