1 / 17

The long term discount rate: Some comments from a practical point of view 24. mai 2012

The long term discount rate: Some comments from a practical point of view 24. mai 2012. Prof. Thore Johnsen Norwegian School of Economics (NHH). Structure. Are economic (growth) models useful in setting public discount rates? A simple market calibration exercise

lea
Download Presentation

The long term discount rate: Some comments from a practical point of view 24. mai 2012

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. The long term discount rate: Some comments from a practical point of view24. mai 2012 Prof. Thore Johnsen Norwegian School ofEconomics (NHH)

  2. Structure • Are economic (growth) modelsuseful in setting public discount rates? • A simple market calibrationexercise • Risk premiuminformation from the stock market • Summing up

  3. Are economic (growth) modelsuseful in setting public discount rates? • Ofcourse, butwith a minimum of market calibration • But, themodels have not beenveryuseful in explaining (or predicting) thefinancial markets Discount rate = Risk free rate (real) + Risk Premium • Risk Free rate puzzle: toohigh • Equity premiumpuzzle: toolow • Too muchdegreeoffreedom in more elaboratemodels, • or toocomplex and unstable for practicaluse

  4. Structure • Are economic (growth) modelsuseful in setting public discount rates? • A simple market calibrationexercise • Few long instruments with «risk free» real return matching except for the UK 50-year indexedGilt-market (excessdemand) • Will insteadusethe US 100-year corporatebond market

  5. 100 Year Bonds - Yields 2001 - 2012 Walt Disney 2093vs 2032 US Treasury 2030 Coca Cola 2098vs 2036 US Treasury 2030

  6. 100 Year Bonds – Yield spreads 2001 - 2012 2093- 2032 WD 2032vsTreasury 2030 2098- 2036 CC 2036vsTreasury 2030

  7.  (TLRL- TSRS) / (TL-TS) 100 Year Bonds – Forward Yields WD93 = WD32 + Fwdpurch. WD93 in 2032 CC98 = CC36 + Fwdpurch. CC96 in 2036

  8. Uncertain future price and yield (in 2032-36) - Convexity adjusted forward yield • Price long bond = Price shortbond + E[Future Price] • Determine forward yield from expectedfuture price Dybvig, et. Al. (JB 1996; Weitzman JEEM 1998)

  9. 100 Year Bonds – Stable 3.2 % Forward Yields R93  [T32R32 + (T93-T32)3.2%]/T93 R98  [T36R36 + (T98-T36)3.2%]/T98

  10. Structure • Are economic (growth) modelsuseful in setting public discount rates? • A simple market calibrationexercise • Risk premiuminformation from the stock market

  11. 30. sep. 2008: Down 8.5 %  SELL !! 1. oktober 2008: Up 5.5 %  BUY !! Twodays in the life of Oslo Stock Exhange….. 11

  12. The stock market is driven by expectations and risk • Stocks give a w return when investors demand more (and a higher return when they expect less) • Stock market and economic growth uncorrelated, across markets and over time (Dimson, Marsh & Staunton) • (but the stock market is a good predictor for future growth) • High correlation between long-run stock and bond returns,while short-run returns are negatively correlated Discount rate = Risk free rate (real) + Risk Premium

  13. Pricing of OSE Large Caps Nov vs Aug 2008 Aug 08: RF 5.0 % MP 4.5 %  Cost 12 % Nov 08: RF 3.8 % MP 7 %  Cost 14.5% 13

  14. Cyclical risk premiums US

  15. NORWAY: 0.60Equity + 0.40Bonds = 3.2 %  GNP-growth US: 0.60Equity + 0.40Bonds = 4.5 % >> GNP-growth Equity, gov. bonds and GNP-growth Norway / US (deflated, log) 1900 - 2010 > 1980 8 % 2.6 % 6,5 % 7 % -GNP: 2.4 % -Real rate:3.8% 6,5 % 2.5 % -GNP: 2.7 % -Real rate:1.8%

  16. 1900-1959: Equity: 3,2% Gov Bonds: 1,1% Real interest: 1,2% 1960-2011: Equity: 5,2% Gov. bonds: 2,9% Real interest: 2,5% 1900-1959: Equity: 6,9% Gov. bonds: 1,1% Real interest: 0,7% 1960-2011: Equity: 5,4% Gov. bonds: 3,3% Real inteest: 1,1% 15-yrs geometric real returns Norway / US 1900 – 2011 NORWAY US

  17. Summing up • Yes, the risk free (real) rate term structure has a dip at the (very) long end • But, thethe term structureof risk premiumsareproblablyupward bending (e.g. Pastor & Stambaug, JF 2012) • Use market calibration (politicaldefense) • More focus on benefits/cash flowsthandiscount rates in public projects

More Related