On alternative methods of treating risk

Abstract

M.J. Gordon, P. J. Halpern and my colleagues at McMaster University for helpful connnents and suggest ions on earlier drafts of this paper. How ever, I ret ain full responsibility for any shortcomings of this paper. On Alternative Methods of Treating Risk I. I ntroduction Two methods for accounting for risk have been suggested in the literature: the certainty equivalent factor (a) and the risk adjusted discount rate (K) methods. Robichek and Myers [3] have analyzed the relation between a and K and concluded that using K "leads to serious contra diction " [3, p. 80]. Chen [l] re-examined the relations between the two risk methods and correctly pointed out that Robichek and Myers ' conclusion is incorrect and stems from their failure to recognize that Kt (where t denotes a time period) , unlike at, reflects in addition to risk and time value of money, a time factor. In this paper we first reclarify the relationship between at and Kt and