Strategic Risk Taking: A Framework for Risk Management

Chapter 5. Risk-Adjusted Value

Risk-averse investors will assign lower values to assets that have more risk associated with them than to otherwise similar assets that are less risky. The most common way of adjusting for risk is to compute a value that is risk adjusted. In this chapter, we will consider four ways in which we can make this risk adjustment. The first two approaches are based on discounted cash flow valuation, where we value an asset by discounting the expected cash flows on it at a discount rate. The risk adjustment here can take the form of a higher discount rate or a reduction in expected cash flows for risky assets, with the adjustment based on some measure of asset risk. The third approach is to do a post-valuation adjustment ...