Black's Simple Discounting Rule
42 Pages Posted: 17 Mar 2008 Last revised: 27 Jan 2013
Date Written: August 21, 2008
We study the implementability of Black's (1988) elegant discounting rule. The rule overcomes thorny problems that traditional valuation approaches struggle with, namely identifying the market portfolio, measuring project risk, and assessing the market risk premium. We offer new theory, showing that the conditional mean cash flow called for in Black's rule equals a given percentile of the cash flow distribution. Moreover, we present evidence that the probability level of the percentile in question is reasonably stationary in time and across countries, and that managers typically have the information our implementation requires. Computing project and firm value with the approach we are proposing is a feasible and theoretically sound alternative to other valuation methods.
Keywords: Black, valuation, discounting, conditional cash flows
JEL Classification: G12, G31
Suggested Citation: Suggested Citation
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By John B. Long