Hostname: page-component-78c5997874-fbnjt Total loading time: 0 Render date: 2024-11-15T14:55:57.382Z Has data issue: false hasContentIssue false
  • English
  • Français

Risk-Adjusted Values, Timing of Uncertainty Resolution, and the Measurement of Project Worth

Published online by Cambridge University Press:  06 April 2009

Richard H. Bernhard
Get access Rights & Permissions [Opens in a new window]

Extract

In the standard setting in which an individual or firm has preferences for probabilistic monetary outcomes that satisfy the Neumann-Morgenstern [10] assumptions of “rational behavior” and has an exponential utility function for money, a popular index for evaluating any proposed single-period probabilistic project is its “risk-adjusted value” (RAV), i.e., its certainty equivalent, the certain amount of money that has the same utility as the expected utility for the project. Since the exponential function is completely characterized by just a single parameter, its risk aversion level, in comparing mutually exclusive projects one can simply plot their RAVs or their expected utilities as a function of this parameter and then, for any given value or range of values of the parameter, read off which project is best, i.e., has the highest RAV or, equivalently, the highest expected utility. (See, e.g., [7], p. 203 or [2].)

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 19 , Issue 1 , March 1984 , pp. 83 - 99
Copyright
Copyright © School of Business Administration, University of Washington 1984

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

[1]Bamberg, Günter, and Spremann, Klaus. “Implications of Constant Risk Aversion.” Zeitschrift für Operations Research, Vol. 25 (1981), pp. 205–224.Google Scholar
[2]Cozzolino, John M. “A New Method for Risk Analysis.” Sloan Management Review, Vol. 20 (Spring 1979), pp. 53–66.Google Scholar
[3]Cozzolino, John M. “Incorporating Delay Risk into Investment Analysis.” Proceedings of the Symposium on Energy Modeling III. Chicago: Institute of Gas Technology (04 1981), pp. 533–543.Google Scholar
[4]Hammond, John S. III, “Simplifying the Choice between Uncertain Prospects Where Preference Is Nonlinear.” Management Science, Vol. 20 (03 1974), pp. 1047–1072.CrossRefGoogle Scholar
[5]Hax, Arnoldo C, and Wiig, Karl M.. “The Use of Decision Analysis in Capital Investment Problems.” Sloan Management Review, Vol. 17 (Winter 1976), pp. 19–48.Google Scholar
[6]Hillier, Frederick S., and Lieberman, Gerald J.. Introduction to Operations Research, third edition. San Francisco: Holden-Day (1980).Google Scholar
[7]Keeney, Ralph L., and Raiffa, Howard. Decisions with Multiple Objectives: Preferences and Value Tradeoffs. New York: John Wiley & Sons, Inc. (1976).Google Scholar
[8]Pollard, Arnold B.A Normative Model for Joint Time/Risk Preference Decision Problems. Menlo Park, CA: Stanford Research Institute (1969).Google Scholar
[9]Pratt, John W. “Risk Aversion in the Small and in the Large.” Econometrica, Vol. 32 (01–04 1964), pp. 122–136.CrossRefGoogle Scholar
[10]Von Neumann, John, and Morgenstern, Oscar. Theory of Games and Economic Behavior, second edition, Princeton, NJ: Princeton University Press (1947).Google Scholar