Nicolas Heinrichs
Ph.D. Student, University of Cologne, Germany.
Stefan Erdorf
Ph.D. Student, University of Cologne, Germany.
Thomas Hartmann-Wendels
University of Cologne, Germany.Diversification in Firm Valuation:
A Multivariate Copula Approach
We introduce a new discounted cash flow model which adopts the
diversification effect of multi-business firms. We face two challenges:
One is examining how different diversification extents can affect the
firm value due to risk reduction, and the other is modeling segment-
specific cash flows and discount rates to reflect the differences in risk
and growth characteristics across the different businesses that a firm
operates in. Since the co-movement of business segments depends on
the state of the economy, we use a multivariate copula approach taking
the state-varying dependence of business segments explicitly into
account. A high level of a firm’s diversification determined by a low
dependence between the firm’s business segments leads to a lower
probability of firm default which results in a higher firm value through
reduced bankruptcy costs. We demonstrate this effect by comparing the
values of three U.S. firms when modeling independence, dependence
with copulas, and perfect dependence between businesses.