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Published: Daniel Chi
Daniel Chi (Finance) is the author of "The Dynamics of Performance Volatility and Firm Valuation," which was published in the Journal of Financial and Quantitative Analysis.This publication is considered to be an A+ journal.
It is well known that riskier firms have lower valuation. But it is equally well known that smaller firms are riskier, yet have higher valuation. How could this be? In the article, Chi shows through a theoretical model (and empirical evidence) that smaller firms have invested in fewer available investment opportunities, that is, they are less diversified, and so more volatile or riskier. Yet, they also have more investment opportunities to invest in the future, and these investment opportunities are reflected by higher valuation. Thus, smaller firms are riskier, yet have higher valuation.