How to Discount Cashflows with Time-Varying Expected Returns

44 Pages Posted: 27 Oct 2003 Last revised: 11 Jun 2022

See all articles by Andrew Ang

Andrew Ang

BlackRock, Inc

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management

Multiple version iconThere are 3 versions of this paper

Date Written: October 2003

Abstract

While many studies document that the market risk premium is predictable and that betas are not constant, the dividend discount model ignores time-varying risk premiums and betas. We develop a model to consistently value cashflows with changing risk-free rates, predictable risk premiums and conditional betas in the context of a conditional CAPM. Practical valuation is accomplished with an analytic term structure of discount rates, with different discount rates applied to expected cashflows at different horizons. Using constant discount rates can produce large mis-valuations, which, in portfolio data, are mostly driven at short horizons by market risk premiums and at long horizons by time-variation in risk-free rates and factor loadings.

Suggested Citation

Ang, Andrew and Liu, Jun, How to Discount Cashflows with Time-Varying Expected Returns (October 2003). NBER Working Paper No. w10042, Available at SSRN: https://ssrn.com/abstract=461363

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States
858.534.2022 (Phone)
5858.534.0745 (Fax)

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