Uncertainty of capital productivity and declining discount rates

Shou Chen, Richard Fu, Lei Wedge and Ziran Zou

Applied Economics Letters, 2019, vol. 26, issue 21, 1779-1784

Abstract: This paper considers the problem of instantaneous certainty-equivalent (ICE) discountrate when future return on capital is uncertain. We show that the ICE discount rate equals the expected return under atransformed risk-adjusted probability measure. Our approach allows us to analyze theICE discount rate regardless of the distribution of future return on capital. We provethat the ICE discount rate decreases as the delay time or the coefficient of relative riskaversion increases in a general setting. Our results lend further supports to adopting thedeclining discount rate (DDR) schedule for long-range projects with uncertain futurereturns on capital.

Date: 2019
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DOI: 10.1080/13504851.2019.1597251

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