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Risk-Adjusted Economic Value Analysis

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  • Alastair Longley-Cook

Abstract

The ability of commonly used profitability measures to reflect risk exposure appropriately is evaluated and found lacking. As an alternative, a modern portfolio theory approach, based on utility theory, is recommended. Generalized formulas for calculating risk-adjusted economic values by deriving risk adjustments from certainty equivalents are developed by using the Markowitz expected utility maxim. Practical applications are described. Where appropriate, simplifying assumptions are shown to result in closed-form solutions, thereby reducing the need for extensive, stochastic cashflow simulations. The resulting formulas can be used to measure financial performance on a risk-adjusted basis consistently across different lines of business or to evaluate risk exposures in strategic alternatives.

Suggested Citation

  • Alastair Longley-Cook, 1998. "Risk-Adjusted Economic Value Analysis," North American Actuarial Journal, Taylor & Francis Journals, vol. 2(1), pages 87-98.
    • Handle: RePEc:taf:uaajxx:v:2:y:1998:i:1:p:87-98
    DOI: 10.1080/10920277.1998.10595678
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    Cited by:

    1. Eckhard Platen, 2009. "Real World Pricing of Long Term Contracts," Research Paper Series 262, Quantitative Finance Research Centre, University of Technology, Sydney.
    2. Kevin Fergusson & Eckhard Platen, 2017. "Less-Expensive Valuation of Long Term Annuities Linked to Mortality, Cash and Equity," Papers 1711.02808, arXiv.org.
    3. Kevin Fergusson & Eckhard Platen, 2013. "Real World Pricing of Long Term Cash-Linked Annuities and Equity-Linked Annuities with Cash-Linked Guarantees," Research Paper Series 338, Quantitative Finance Research Centre, University of Technology, Sydney.

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