The Risk-Adjusted Rate: Correcting Its Errors and Reflecting on Risk

74 Pages Posted: 31 Aug 2018

See all articles by Roger Mesznik

Roger Mesznik

Graduate Business School -- Fin/Eco

Date Written: August 22, 2018

Abstract

We prove that the use of the risk-adjusted rate (RAR) for compounding and discounting outflows conflicts irremediably with risk aversion. It is correct for inflows. Our correction respects the impact of risk on outflows; it conforms to risk aversion. It solves many unsolved issues. Our examples offer also new insights. We prove that the RAR underestimates the PV of future outflows and overestimates the FV of current outflows. We prove that the PV of a future outflow can be a larger absolute number than the cashflow itself. We prove that the use of the RAR is a special case.

Keywords: risk-adjusted rate, discount outflows, errors in NPV

JEL Classification: G31, G34, M21

Suggested Citation

Mesznik, Roger, The Risk-Adjusted Rate: Correcting Its Errors and Reflecting on Risk (August 22, 2018). Columbia Business School Research Paper No. 18-69. Available at SSRN: https://ssrn.com/abstract=3237124 or http://dx.doi.org/10.2139/ssrn.3237124

Roger Mesznik (Contact Author)

Graduate Business School -- Fin/Eco ( email )

3022 Broadway
New York, NY 10027
United States

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