The Risk-Adjusted Rate: Correcting Its Errors and Reflecting on Risk
74 Pages Posted: 31 Aug 2018
Date Written: August 22, 2018
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
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