How to Discount Cashflows with Time-Varying Expected Returns

46 Pages Posted: 31 May 2002

See all articles by Andrew Ang

Andrew Ang

BlackRock, Inc

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management

Multiple version iconThere are 3 versions of this paper

Date Written: May 9, 2002

Abstract

While many studies document that the market risk premium is predictable and that betas are not constant, the standard dividend discount model ignores these effects. This paper shows how to value cashflows with changing risk-free rates, predictable risk premiums and time-varying betas, by calculating a series of discount rates which take into account these effects. Using a constant discount rate can produce large misvaluations in portfolio data, which are mostly driven at long horizons by variation in risk-free rates and factor loadings.

Keywords: present value, discount rates, term structure of expected returns, time-varying beta, time-varying risk premium, capital budgeting

JEL Classification: E43, G12

Suggested Citation

Ang, Andrew and Liu, Jun, How to Discount Cashflows with Time-Varying Expected Returns (May 9, 2002). Available at SSRN: https://ssrn.com/abstract=311594 or http://dx.doi.org/10.2139/ssrn.311594

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States
858.534.2022 (Phone)
5858.534.0745 (Fax)

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