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Answering the social discount rate question

Szekeres, Szabolcs (2022): Answering the social discount rate question.

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Discounting project net flows with prescriptive rates fails to reflect costs of capital; discounting them with descriptive rates fails to reflect intertemporal preferences. A two-rate discounting method is described by which a descriptive rate is used to forecast costs of capital and a prescriptive rate is used to discount the all-inclusive net benefit flow. Using this method is the equivalent of discounting with the social time preference rate (SPTR) after having adequately shadow-priced investments, which satisfies in full the requirements of both discounting approaches. It also results in an easy to apply rule: for projects to be economically feasible their IRR should exceed both the STPR and the social opportunity cost rate (SOCR). The long-standing social discount-rate dilemma is thus solved, for in fact there is no choice. Both rates must be used. An agent-based capital market model with multiple actors and two financial instruments, one of them stochastic, illustrates and provides additional insights.

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