IDEAS home Printed from https://ideas.repec.org/a/bla/eufman/v2y1996i2p157-167.html
   My bibliography  Save this article

Arithmetic versus geometric mean estimators: Setting discount rates for capital budgeting

Author

Listed:
  • Ian Cooper

Abstract

This paper addresses an issue central to the estimation of discount rates for capital budgeting: should the geometric mean or arithmetic mean of past data be used when estimating the discount rate? the use of the arithmetic mean ignores estimation error and serial correlation in returns. Unbiased discount factors have been derived that correct for both these effects. In all cases, the corrected discount rates are closer to the arithmetic than the geometric mean.

Suggested Citation

  • Ian Cooper, 1996. "Arithmetic versus geometric mean estimators: Setting discount rates for capital budgeting," European Financial Management, European Financial Management Association, vol. 2(2), pages 157-167, July.
    • Handle: RePEc:bla:eufman:v:2:y:1996:i:2:p:157-167
    DOI: 10.1111/j.1468-036X.1996.tb00036.x
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/j.1468-036X.1996.tb00036.x
    Download Restriction: no
    File URL: https://libkey.io/10.1111/j.1468-036X.1996.tb00036.x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Poterba, James M. & Summers, Lawrence H., 1988. "Mean reversion in stock prices : Evidence and Implications," Journal of Financial Economics, Elsevier, vol. 22(1), pages 27-59, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Breuer, Wolfgang & Gürtler, Marc, 2010. "Implied rates of return, the discount rate effect, and market risk premia," Working Papers IF33V3, Technische Universität Braunschweig, Institute of Finance.
    2. Rui Alpalhao & Paulo Alves, 2005. "The Portuguese equity risk premium: what we know and what we don't know," Applied Financial Economics, Taylor & Francis Journals, vol. 15(7), pages 489-498.
    3. Alan Gregory, 2011. "The Expected Cost of Equity and the Expected Risk Premium in the UK," Review of Behavioral Finance, Emerald Group Publishing Limited, vol. 3(1), pages 1-26, April.
    4. Christoph Kaserer, 2022. "Estimating the market risk premium for valuations: arithmetic or geometric mean or something in between?," Journal of Business Economics, Springer, vol. 92(8), pages 1373-1415, October.
    5. Wolfgang Breuer & Karsten Kohn & Klaus Mark, 2017. "A note on corporate valuation using imprecise cost of capital," Journal of Business Economics, Springer, vol. 87(6), pages 709-747, August.
    6. Chandra Shekhar Bhatnagar & Riad Ramlogan, 2012. "The capital asset pricing model versus the three factor model: A United Kingdom Perspective," International Journal of Business and Social Research, LAR Center Press, vol. 2(1), pages 51-65, February.
    7. Missiakoulis, Spyros & Vasiliou, Dimitrios & Eriotis, Nikolaos, 2012. "Forecasting Performance with the Harmonic Mean: Long-Term Investment Horizons in Shanghai Stock Exchange," Review of Applied Economics, Lincoln University, Department of Financial and Business Systems, vol. 8(1), pages 1-11, May.
    8. Jie Zhu, 2019. "Estimating The Equity Risk Premium: The Case Of Greater China," Bulletin of Monetary Economics and Banking, Bank Indonesia, vol. 22(2), pages 195-212, July.
    9. Helena Jasiulewicz & Wojciech Kordecki, 2016. "Multiplicative parameters and estimators: applications in economics and finance," Annals of Operations Research, Springer, vol. 238(1), pages 299-313, March.
    10. Mark Freeman & Ben Groom, 2015. "Using equity premium survey data to estimate future wealth," Review of Quantitative Finance and Accounting, Springer, vol. 45(4), pages 665-693, November.
    11. Brian McCulloch, 2003. "Geometric Return and Portfolio Analysis," Treasury Working Paper Series 03/28, New Zealand Treasury.
    12. Philip Ndikum, 2020. "Machine Learning Algorithms for Financial Asset Price Forecasting," Papers 2004.01504, arXiv.org.
    13. Chandra Shekhar Bhatnagar & Riad Ramlogan, 2012. "The capital asset pricing model versus the three factor model: A United Kingdom Perspective," International Journal of Business and Social Research, MIR Center for Socio-Economic Research, vol. 2(1), pages 51-65, February.
    14. Sonntag, Dominik, 2018. "Die Theorie der fairen geometrischen Rendite [The Theory of Fair Geometric Returns]," MPRA Paper 87082, University Library of Munich, Germany.
    15. Eduardo Walker, 2016. "Cost of Capital in Emerging Markets: Bridging Gaps between Theory and Practice," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 53(1), pages 111-147, December.
    16. Helena Jasiulewicz & Wojciech Kordecki, 2016. "Multiplicative parameters and estimators: applications in economics and finance," Annals of Operations Research, Springer, vol. 238(1), pages 299-313, March.
    17. Burkhard Pedell, 2007. "Kapitalmarktbasierte Ermittlung des Kapitalkostensatzes für Zwecke der Entgeltregulierung," Metrika: International Journal for Theoretical and Applied Statistics, Springer, vol. 18(1), pages 35-60, April.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Ngene, Geoffrey & Tah, Kenneth A. & Darrat, Ali F., 2017. "Long memory or structural breaks: Some evidence for African stock markets," Review of Financial Economics, Elsevier, vol. 34(C), pages 61-73.
    2. Yoon, Byung-Sam & Brorsen, B. Wade, 2005. "Can Multiyear Rollover Hedging Increase Mean Returns?," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 37(1), pages 65-78, April.
    3. Shyh-Wei Chen, 2008. "Non-stationarity and Non-linearity in Stock Prices: Evidence from the OECD Countries," Economics Bulletin, AccessEcon, vol. 3(11), pages 1-11.
    4. Nam, Kiseok & Pyun, Chong Soo & Kim, Sei-Wan, 2003. "Is asymmetric mean-reverting pattern in stock returns systematic? Evidence from Pacific-basin markets in the short-horizon," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 13(5), pages 481-502, December.
    5. Neely, Christopher J. & Weller, Paul, 2000. "Predictability in International Asset Returns: A Reexamination," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(4), pages 601-620, December.
    6. Mohamed Es-Sanoun & Jude Gohou & Mounir Benboubker, 2023. "Testing of Herd Behavior In african Stock Markets During COVID-19 Pandemic [Essai de vérification du comportement mimétique dans les marchés boursiers africains au cours de la crise de covid-19]," Post-Print hal-04144289, HAL.
    7. Nadiezhda de la Uz, 2002. "La hipótesis de martingala en el mercado bursátil mexicano," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 17(1), pages 91-127.
    8. John Sabelhaus, 2005. "Alternative Methods for Projecting Equity Returns: Implications for Evaluating Social Security Reform Proposals," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 8(1), pages 43-63, March.
    9. Ajit Singh, 1998. "Pension Reform, the Stock Market, Capital Formation and Economic Growth: A Critical Commentary on the World Bank’s Proposals," Istanbul Stock Exchange Review, Research and Business Development Department, Borsa Istanbul, vol. 2(8-7), pages 51-78.
    10. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-738, August.
    11. Shu-Ling Chen & Hyeongwoo Kim, 2011. "Nonlinear Mean Reversion across National Stock Markets: Evidence from Emerging Asian Markets," International Economic Journal, Taylor & Francis Journals, vol. 25(2), pages 239-250.
    12. Semenov, Andrei, 2021. "Measuring the stock's factor beta and identifying risk factors under market inefficiency," The Quarterly Review of Economics and Finance, Elsevier, vol. 80(C), pages 635-649.
    13. Bonomo, Marco & Garcia, Rene, 1996. "Consumption and equilibrium asset pricing: An empirical assessment," Journal of Empirical Finance, Elsevier, vol. 3(3), pages 239-265, September.
    14. Gil-Alana, L.A., 2006. "Fractional integration in daily stock market indexes," Review of Financial Economics, Elsevier, vol. 15(1), pages 28-48.
    15. Peng, Lin & Xiong, Wei, 2006. "Investor attention, overconfidence and category learning," Journal of Financial Economics, Elsevier, vol. 80(3), pages 563-602, June.
    16. Dmitry Kulikov, 2012. "Testing for Rational Speculative Bubbles on the Estonian Stock Market," Research in Economics and Business: Central and Eastern Europe, Tallinn School of Economics and Business Administration, Tallinn University of Technology, vol. 4(1).
    17. John Y. Campbell & Yeung Lewis Chanb & M. Viceira, 2013. "A multivariate model of strategic asset allocation," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part II, chapter 39, pages 809-848, World Scientific Publishing Co. Pte. Ltd..
    18. Dai, R., 2010. "Essays on pension finance and dynamic asset allocation," Other publications TiSEM 72fdbf1a-5a77-410d-bb4e-9, Tilburg University, School of Economics and Management.
    19. Dichtl, Hubert & Drobetz, Wolfgang, 2011. "Portfolio insurance and prospect theory investors: Popularity and optimal design of capital protected financial products," Journal of Banking & Finance, Elsevier, vol. 35(7), pages 1683-1697, July.
    20. Dooruj Rambaccussing, 2011. "Do Mean Reverting based trading strategies outperform Buy and Hold?," Working Papers 1113, Department of Applied Economics II, Universidad de Valencia.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:eufman:v:2:y:1996:i:2:p:157-167. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/efmaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.