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Biases and Error Measures: How to Compare Valuation Methods
Ingolf Dittmann, Erasmus University Rotterdam
Ernst Maug, University of Mannheim
ABSTRACT. This paper shows that the error measure is a critical design feature in a horse race between different valuation methods. We investigate three error measures (percentage errors, absolute percentage errors, and logarithmic errors) and show that the ranking of valuation methods in terms of bias and root mean-squared error depends largely on the error measure chosen. Percentage errors have a limited downside and therefore favour methods that produce low valuations. We demonstrate this point in two applications. We compare (1) four multiple valuation methods (averaging with the arithmetic mean, harmonic mean, median, and the geometric mean) and (2) three present value approaches (dividend discount model, discounted cash flow model, residual income model).
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