Open Access

Certainty equivalent, risk premium and asset pricing

Frontiers of Business Research in ChinaSelected Publications from Chinese Universities20104:15

https://doi.org/10.1007/s11782-010-0015-1

Received: 27 May 2009

Published: 23 May 2010

Abstract

This paper attempts to determine the certainty equivalent of an uncertain future cash flow or value through the option pricing method, and builds models of certainty equivalent and certainty equivalent coefficient. Based on the model of certainty equivalent coefficient, this paper further derives models of risk premium and risk-adjusted discount rate. The latter is a new capital asset pricing model (CAPM) accounting for total risk rather than with only the systematic risk accounted for as in the current CAPM. The reliability in relevant financial analysis, valuation, decision making and risk management may be enhanced with these new models.

Keywords

certainty equivalent certainty equivalent coefficient risk premium CAPM real option put option

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