How to Discount Cashflows with Time-Varying Expected Returns [report]

Andrew Ang, Jun Liu
2003 unpublished
While many studies document that the market risk premium is predictable and that betas are not constant, the dividend discount model ignores time-varying risk premiums and betas. We develop a model to consistently value cashf lows with changing risk-free rates, predictable risk premiums, and conditional betas in the context of a conditional CAPM. Practical valuation is accomplished with an analytic term structure of discount rates, with different discount rates applied to expected cashf lows at
more » ... ected cashf lows at different horizons. Using constant discount rates can produce large misvaluations, which, in portfolio data, are mostly driven at short horizons by market risk premiums and at long horizons by time variation in risk-free rates and factor loadings. * Ang is with Columbia University and NBER. Jun Liu is at UCLA. We would like to
doi:10.3386/w10042 fatcat:gnudnzs2pjhlxapcxuwgpnxl2u