Project Valuation in the Presence of Loss Aversion During Economic Crises
Strategic Change: Briefings in Entrepreneurial Finance, Vol. 20, Nos. 5/6, pp. 171-86, 2011
33 Pages Posted: 22 Apr 2008 Last revised: 15 Jun 2016
Date Written: November 19, 2010
During and after economic crisis, there is a tendency to have less projects approved owing to loss aversion. The paper introduces a modification of the risk premium in order to take into account one behavioral aspect, that of loss aversion, which is not considered in the traditional method. Loss aversion distinguishes losses from gains in a nonlinear value function. Thus, if the range of possible outcomes includes losses and gains, the use of beta is put into doubt. The paper examines possible ways to save the use of beta for discounted cash flow analysis by revising the standard formulae and it provides a simulation with this newly generated method.
Keywords: behavioral finance, corporate finance, project evaluation, WACC, cost of capital, psychology, bias
JEL Classification: D7, D8, D81, D21, D23, G31, L2
Suggested Citation: Suggested Citation