The Conditional Validity of Risk-Adjusted Discounting

Abstract: The constellation of the initiatives of ERM, Solvency II, and International Accounting traces back through capital management to modern finance and portfolio theory. These supposedly dynamic and marketoriented initiatives will eventually disappoint the (re)insurance industry, if they uncritically endorse risk-adjusted discounting. One’s job is rendered more difficult, if not impossible, without the right tools. Building on earlier papers, the author will here show how a seminal academic paper from the 1960s contains the seeds of the downfall of risk-adjusted discounting. It is too much to expect a retraction, but hopefully, the emerging standards for these initiatives at least will not force risk-adjusted discounting upon the practitioners.

Keywords: present value, risk-adjusted discounting, stochastic cash flow.