Hostname: page-component-7479d7b7d-m9pkr Total loading time: 0 Render date: 2024-07-12T10:31:46.587Z Has data issue: false hasContentIssue false

Certainty Equivalents and Timing Uncertainty

Published online by Cambridge University Press:  19 October 2009

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
Copyright
Copyright © School of Business Administration, University of Washington 1975

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

REFERENCES

[1]Boness, A. J.A Pedagogic Note on the Cost of Capital.” Journal of Finance, March 1964, pp. 99106.CrossRefGoogle Scholar
[2]Fama, E.Multiperiod Consumption-Investment Decisions.” American Economic Review, March 1970, pp. 163174.Google Scholar
[3]Haley, C. W., and Schall, L. D.. The Theory of Financial Decisions. New York: McGraw-Hill, 1973.Google Scholar
[4]Hillier, F.The Derivation of Probabilistic Information for the Evaluation of Risky Investments.” Management Science, Volume 9, No. 3 (April 1963), pp. 443457.CrossRefGoogle Scholar
[5]Keeley, R. H., and Westerfield, P.. “A Problem in Probability Distribution Techniques for Capital Budgeting.” Journal of Finance, June 1972, pp. 703–9.CrossRefGoogle Scholar
[6]Mansfield, E.Industrial Research and Technological Innovation. New York: Norton, 1968.Google Scholar
[7]Myers, S. C.A Time-State Preference Model of Security Valuation.” Journal of Financial and Quantitative Analysis, June 1968, pp. 133.CrossRefGoogle Scholar
[8]Perrakis, S., and Henin, C.. “The Evaluation of Risky Investments with Random Timing of Cash Returns.” Management Science, Volume 21, No. 1 (September 1974), pp. 7986.CrossRefGoogle Scholar
[9]Perrakis, S., and Sahin, I.. “On Risky Investments with Random Timing of Cash Returns and Fixed Planning Horizon.” Management Science (forthcoming).Google Scholar
[10]Robicheck, A., and Myers, S. C.. “Conceptual Problems in the Use of Risk Adjusted Discount Rates.” Journal of Finance, December 1966, pp. 727730.Google Scholar
[11]Samuelson, P.Lifetime Portfolio Selection by Dynamic Stochastic Programming.” Review of Economics and Statistics, August 1969, pp. 239246.CrossRefGoogle Scholar
[12]Van Home, J.Financial Management and policy, 2nd ed.Englewood Cliffs, N.J.: Prentice-Hall, 1971.Google Scholar
[13]Weingartner, H. M.Some New Views on the Payback Period and Capital Budgeting Decisions.” Management Science, Volume 15, No. 12 (August 1969), pp. 594607.CrossRefGoogle Scholar