Showing papers on "Stochastic discount factor published in 1976"

A portfolio theory of the social discount rate and the public debt

Abstract: FEW OF US have not at some time become intrigued with the relation between the social and the private discount rates. My interest in the subject was renewed by a series of papers by Arrow [1966], Hirschleifer [1966], Bailey and Jensen [1972], and others. These papers used state preference or capital asset pricing theory to deomonstrate that with perfect and complete capital markets the government is no more efficient than the capital markets as a means for diversifying away risk, and that the social and private discount rates are the same. Special circumstances may limit the effectiveness with which government or capital markets can be used to diversify away risk, and in such circumstances either the private or the social discount rate would be raised. Notwithstanding the apparent validity of this argument, I remained of the opinion that even with perfect and complete capital markets the social discount rate may be below the private rate. Therefore, I was confronted with the task of establishing what attributes of government the Arrow-Hirschleifer model of the problem failed to recognize. Those of you who are familiar with my previous work will find my conclusions here a predictable outcome of that work. I have for some time disputed the Modigliani-Miller theorem that a firm's cost of capital is independent of its leverage rate in the absence of taxes, or stated differently, that the corporate discount rate is the same as the private discount rate. Their theorem assumes personal leverage is a perfect substitute for corporate leverage while my position has been that this assumption is, in fact, not valid. The Arrow-Hirschleifer theorem requires, it seems to me, an even more untenable assumption-that personal leverage is a perfect substitute for government leverage. It would then follow that government is a legal fiction of no economic significance, that financial intermediation by government has no impact on the wealth and income of persons. However, this assumption ignores a unique property of government. It is the only debtor that can raise the funds required to meet its debts by printing money.1 Consideration of the possible advantages of financial intermediation by government on the micro level led me to the conclusion that as long as the government debt is small and inflation is not a problem, the social discount rate is well below the private discount rate. However, with analysis confined to the micro level, some questions must inevitably be left hanging which cast doubt on the validity of this conclusion. I therefore was forced to carry the inquiry forward to the macro level

Consistency of risk attitude in the investment decision process

Abstract: Risky investments are analyzed through a computer simulation process or with the use of the risk-adjusted discount rate and certainty-equivalent coefficient. A constant risk-adjusted discount rate or certainty-equivalent coefficient is frequently used in the evaluation of risky projects, while a constant risk-aversion coefficient is used in the simulation approach. The question raised in this paper is that one's consistent risk attitude is properly reflected in the risk analysis. Each approach was compared to each other to see if the risk-adjusted discount rate and certainty-equivalent coefficient become constant when the risk-aversion coefficient is held constant. Namely, this paper shows that the risk-adjusted discount rate and certainty-equivalent coefficient should be different from project to project to have a consistent risk attitude. Indeed, if a constant risk-adjusted discount rate or certainty-equivalent coefficient is used, variant risk-aversion coefficients or risk attitudes would be the result.