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Certainty Equivalents and Timing Uncertainty

Published online by Cambridge University Press:  19 October 2009

Stylianos Perrakis
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Extract

Three important methods exist for the treatment of risk in capital budgeting problems: the certainty equivalent method (CE), the risk-adjusted discount method (RAD), and the probability distribution or Hillier-Hertz approach (PD, based on [4]). Each one of these methods evaluates the multiperiod stream of risky returns generated by an investment for given distributions of the returns in each period. A common assumption for all three methods is the certainty of the occurrence of a given risky cash inflow (defined by its distribution) in a given time period. This assumption is probably derived from accounting practices. In references [8] and [9] the PD approach was generalized by removing the certain timing assumption. This paper examines the implications of random timing of cash returns within the framework of the better known CE method.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 10 , Issue 1 , March 1975 , pp. 109 - 118
Copyright
Copyright © School of Business Administration, University of Washington 1975

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References

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