In
finance, relative value is the attractiveness measured in terms of
risk
In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environm ...
,
liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Liq ...
, and
return of one
financial instrument relative to another, or for a given instrument, of one
maturity relative to another. The concept arises in
economics
Economics () is the social science that studies the production, distribution, and consumption of goods and services.
Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics analyzes ...
,
business and
investment.
In hedge funds
The use of relative value is a method of determining an asset's value that takes into account the value of similar assets. In contrast, absolute value looks only at an asset's intrinsic value and does not compare it to other assets. Calculations that are used to measure the relative value of stocks include the enterprise ratio and price-to-earnings ratio.
Prices
Prices of valued items undergo questionable fluctuations. For example, even though housing provides the same utility to the individual over time, and the housing stock is relatively constant or stable, the relative price of housing fluctuates. This holds even more so with
stocks,
oil
An oil is any nonpolar chemical substance that is composed primarily of hydrocarbons and is hydrophobic (does not mix with water) & lipophilic (mixes with other oils). Oils are usually flammable and surface active. Most oils are unsaturated ...
and
gold
Gold is a chemical element with the symbol Au (from la, aurum) and atomic number 79. This makes it one of the higher atomic number elements that occur naturally. It is a bright, slightly orange-yellow, dense, soft, malleable, and ductile me ...
.
This price volatility appears to occur in cycles and is caused by a myriad of factors.
The chart to the right is an attempt to overlay the prices of
housing
Housing, or more generally, living spaces, refers to the construction and assigned usage of houses or buildings individually or collectively, for the purpose of shelter. Housing ensures that members of society have a place to live, whether i ...
, stocks, oil and gold by normalizing the price streams. Normalizing is achieved by applying a discounting formula which converts a price to the price it would be at a certain date, given a certain discount rate. This would normally be used to cancel the effects of inflation, in which case the inflation rate would be used.
In this case the rate is derived as follows: A trend was calculated for the resulting discounted price curve using the method of "least squares". The discount rate was then derived by seeking the goal of a trend of 1, i.e. flat. For housing this normalization rate was 6.06% considering the data from 1940 to 2010 relative to the year 1990. Using this as a baseline rate, the normalized price curves were calculated for the other commodities. Oil and gold had similar normalization rates, but Stocks tended to beat this trend, while rents tended to lose against this trend in the period observed. Gold was the most volatile along with Oil in close second. Stocks were highly volatile. Housing and rents were the least volatile of the commodities studied.
See also
*
Resource-based relative value scale Resource-based relative value scale (RBRVS) is a schema used to determine how much money medical providers should be paid. It is partially used by Medicare in the United States and by nearly all health maintenance organizations (HMOs).
RBRVS assig ...
*
Valuation (finance)#Valuation overview
References
{{DEFAULTSORT:Relative Value (Economics)
Investment management