Measuring Risk

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by Tuck Communications   Dec 09, 2010

Markets hate uncertainty. But traditional earnings volatility measurements, which allow investors get a better handle on risk, aren’t necessarily helping to clear things up.

Tuck assistant professor Robert Resutek says this is because they are based on a firm’s historical earnings trends and, as such, do not provide a reliable picture of uncertainty for current earnings. To better capture volatility in real time, Resutek and a colleague came up with a model of their own based on data culled from a cross-section of similar firms rather than on earnings from a single firm.

The researchers say the new measurement can be particularly useful in assessing risk in newer companies, which are prone to volatility but do not have a long history of earnings. “We care about the uncertainty of future earnings,” explains Resutek, “irrespective of what happened in the past.”

“Earnings Volatility, Earnings Prediction, and Future Stock Returns”