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Should CBA use descriptive or prescriptive discount rates? It should use both!

Szekeres, Szabolcs (2021): Should CBA use descriptive or prescriptive discount rates? It should use both!

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Abstract

Discounting project net flows that exclude financing costs with prescriptive rates fails to reflect costs of capital; discounting them with descriptive rates fails to reflect intertemporal preferences. A hybrid discounting method is proposed whereby descriptive rates are used to forecast costs of capital and prescriptive rates are used to discount all-inclusive net welfare flows. An agent-based capital market model audits the performance of alternative discounting approaches. There is no need to reconcile the discounting approaches. They should be viewed as complementary, not as competing. They are both necessary, and only jointly sufficient to achieve optimality in intertemporal resource allocation.

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