MEASURES OF RISK IN THE STOCK MARKET AND THE VALUATION OF CORPORATE STOCK*

Abstract

IN THIS WORK I have discussed three main questions: (a) What are appropriate measures of corporate risk? (b) What is appropriate form to test the riskiness of a suggested risk measure?; and (c) What are other determinants of a firm's value? Three alternative measures of risk for individual stocks were compared: (a) beta risk measure; (b) turnover ratio of firm's stock; and (c) firm's size. The first two measures can be regarded as market determined measures of risk. The beta risk measure is derived from now commonly accepted Sharpe-Lintner The turnover ratio can be regarded as a proxy for differences among and changes of investors' expectations and may measure flow of new (not previously expected) information with regard to stock. Firms with a higher flow of new information are predicted to have higher price fluctuations, and are considered riskier by investors. A similar association between speculative trading and risk was in fact suggested more than 80 years ago in distinguished work of Grosvenor [1]. The size variable is basically a determinant of risk, and it is used to test a possible effect of size on firm's risk, returns and value. First, there is a clear positive association between first two risk measures, and both bear a negative relationship to firm's size. These results are consistent with hypothesis.' Chapter II compared these three measures using a rate of return framework which tries to relate future return to current risk measure, in context of a simple version of market model. The result indicates that first two measures explain more consistently return to individual stocks where more risky stocks rise more in a rising and fall more in a falling market. There was no similar relationship between stock return and firm's size. Beta seems to be a slightly better measure than turnover ratio in explaining return. Note, however, that this test is clearly a biased test toward beta which is also estimated in a similar framework. Also, a time series comparison in Chapter III did not show any clear relationship between return and turnover ratio of a given stock over time. Chapter IV compared above risk measures in a valuation framework. The main idea was that given stock earnings per share riskier firms will have lower prices. The results in this framework were quite different. Firms with higher turnover ratios apparently are considered riskier and have lower stock prices for given