Generalized Makeham's Formula and Economic Profitability

23 Pages Posted: 28 Sep 2013 Last revised: 25 Apr 2015

See all articles by Carlo Alberto Magni

Carlo Alberto Magni

Università degli studi di Modena e Reggio Emilia (UNIMORE) - School of Doctorate E4E (Engineering for Economics-Economics for Engineering)

Date Written: September 26, 2013

Abstract

This paper generalizes Makeham’s formula, allowing for varying interest rates and for a non-flat structure of valuation rates. An average interest rate (AIR) is introduced, as well as an average valuation rate (AVR), which exist and are unique for any asset. They can be computed either as principal-weighted arithmetic means or as interest-weighted harmonic means of period rates. Economic profitability of an asset or a portfolio of assets is captured by the spread between AIR and AVR, which has the same sign as the Net Present Value. This makes (i) AIR a more reliable tool for valuation and decision than the venerable Internal Rate of Return, and (ii) AVR a natural generalization of the cost-of-capital notion.

Keywords: Makeham’s formula, net present value, average interest rate, internal rate of return

JEL Classification: G11, G12, G31

Suggested Citation

Magni, Carlo Alberto, Generalized Makeham's Formula and Economic Profitability (September 26, 2013). Insurance: Mathematics and Economics, 53(3) (November), 747‒756, 2014. DOI: 10.1016/j.insmatheco.2013.09.014, Available at SSRN: https://ssrn.com/abstract=2331259

Carlo Alberto Magni (Contact Author)

Università degli studi di Modena e Reggio Emilia (UNIMORE) - School of Doctorate E4E (Engineering for Economics-Economics for Engineering) ( email )

Italy

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