Common Stock Valuation Models: Estimation of the Discount Rate Using the Geometric-Mean Criterion
Baylor Business Studies, Vol. 7, No. 2, pp. 41-45, May-June-July-August 1976
5 Pages Posted: 5 Jun 2015 Last revised: 7 Nov 2015
Date Written: November 5, 2015
Abstract
Given the sensitivity of stock valuation models to the discount rate k*, it follows that their operational usefulness is significantly dependent upon the accuracy of the estimate of k*. The purpose of this study is to illustrate the use of the geometric mean to estimate k*. The usual approach to estimating k* is to somehow add a risk premium to the riskless rate. However, this study describes a particular way of estimating the risk-adjusted rate, k* -- an approach consistent with the application of the geometric-mean criterion to the selection of mutual exclusive investments.The geometric mean has long been argued as a normative criterion for choice among risk ventures.
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