underlying asset and the variancein that value cannot be
extractedfrom financialmarkets andhaveto be estimated.
Thus the final values obtained from these applications of
option pricing models have much more estimation error
associatedwiththemthanthevaluesobtainedintheirmore
standard applications (to value short-term traded options).
ROLE OF VALUATION
Valuationisusefulinawiderangeoftasks.Theroleitplays,
however, is different in different arenas. The following
section lays out the relevance of valuation in portfolio
management,inacquisitionanalysis,incorporatefinance,and
for legal and tax purposes.
Valuation in Portfolio Management
The role that valuation plays in portfolio management is
determinedinlargepartbytheinvestmentphilosophyofthe
investor. Valuation plays a minimal role in portfolio
managementforapassiveinvestor,whereasitplaysalarger
roleforanactiveinvestor.Evenamongactiveinvestors,the
natureandtheroleofvaluationisdifferentfordifferenttypes
ofactiveinvestment.Markettimersusevaluationmuchless
thaninvestorswhopickstocks,and thefocusisonmarket
valuationratherthanonfirm-specificvaluation.Amongstock
pickers, valuation plays a central role in portfolio
managementforfundamentalanalysts,andaperipheralrole
for technical analysts.
Thefollowingsubsectionsdescribe,inbroadterms,different
investmentphilosophiesandtherolesplayedbyvaluationin
each one.