Arithmetic Versus Geometric Mean Estimators: Setting Discount Rates for Capital Budgeting
EUROPEAN FINANCIAL MANAGEMENT, Vol. 2 No. 2, 1996
Posted: 2 Jul 1998
This paper addresses an issue central to the estimaiton of discount rates for capital budgeting: should the geometric mean or arithmetic mean of past data be used when estimating the discount rate? The use of the arithmetic mean ignores estimation error and serial correlation in returns. Unbiased discount factors have been derived that correct for both these effects. In all cases, the corrected discount rates are closer to the arithmetic than the geometric mean.
JEL Classification: G12, G31
Suggested Citation: Suggested Citation