Multiplicative Risk Premiums

Douglas D. Gregory

Journal of Financial and Quantitative Analysis, 1978, vol. 13, issue 5, 947-963

Abstract: The certainty-equivalent method of evaluating risky investments has been widely discussed in the literature ([2], [5], [14, p. 356], [19], [20]) and consists of applying a multiplicative factor, αt, to each period's expected cash flow, μt, to produce a certainty-equivalent flow, αtμt. The certainty-equivalent flow is then discounted with the riskless rate of interest, αtμt/(l + i)t. Although there has been much discussion of αt, researchers have not derived explicit expressions for αt, relying instead on ad hoc graphs [24, p. 328] or arguments involving mean-variance indifference curves [2] which may not even exist ([4], [12], [22], [23]). In this paper, I will (1) provide a rigorous definition of αt, (2) derive formal expressions for a for αt three special cases, (3) discuss relationships between αt and σt, the standard deviation of the period t cash flow, (4) formally derive the period t risk-adjusted discount rate, kt, from assumptions concerning the decision maker's (d. m.'s) risk preferences and cash flow distribution, and (5) apply the preceding results to a specific problem involving calculation of the risk-adjusted present value of an uncertain cash flow stream.

Date: 1978
References: Add references at CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://www.cambridge.org/core/product/identifier/ ... type/journal_article link to article abstract page (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cup:jfinqa:v:13:y:1978:i:05:p:947-963_01

Access Statistics for this article

More articles in Journal of Financial and Quantitative Analysis from Cambridge University Press Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK.
Bibliographic data for series maintained by Kirk Stebbing ().