Financial Forecasting, Risk and Valuation: Accounting for the Future

Valuation involves forecasting payoffs and discounting expected payoffs for risk. Forecasting is often seen as the province of the statistician, risk determination the province of asset pricing. This paper elaborates on the idea that financial forecasting, risk determination and valuation are a matter of accounting. Accounting not only provides information to forecast payoffs but also specifies the payoffs to be forecasted. Further, accounting determines the transition from the present to the future and thus implicitly the evolutionary parameters that a statistician might estimate for forecasting. Accounting also bears on risk determination in the way it handles uncertainty. Accordingly, accounting is involved in both the numerator and the denominator of a valuation model. Indeed, a valuation model is a model of accounting for the future, and the effectiveness of a valuation model rides on the accounting principles employed.