Compensatory Damages and the Appropriate Discount Rate: A Comment

Section: The Main Argumentmentioning

confidence: 99%

The “Income-Variance” Risk Factor and Jones & Laughlin v. Pfeifer Guidelines for the Calculation of Present Value

Breeden

2002

“…The correct discount rate to apply is one which is risk-adjusted to counterbalance the forecast uncertainties associated with estimating future losses. (Margulis, 1992, p. 41) This position has been challenged by Albrecht (1993Albrecht ( , 1997, who has attempted to show, using simple algebra, that a risk-free rate should be used to discount expected earnings. Albrecht first assumes that the expected future loss has been calculated and is known.…”

Section: Economic Argumentsmentioning

confidence: 99%

Risk, Discounting, and the Present Value of Future Earnings

Brush

2003

Discounting Damage Awards Using the Zero Coupon Treasury Curve: Satisfying Legal and Economic Theory While Matching Future Cash Flow Projections

Rosenberg¹

2010

How to calculate damage awards has long been the subject of academic dispute. Much focus has been on what is the appropriate discount rate to convert future lost earnings into a lump sum amount. Conflicting or ambiguous legal guidance by the courts has lead to wide disparities in discount rate methodology. This paper presents a fresh, alternative approach to valuing lost earnings in damage awards using current market data from the zero coupon Treasury bond curve. Unlike many other approaches this approach satisfies legal requirements while offering several theoretical and practical benefits: (a) default free discounting; (b) market-based prices and yields; (c) a fully objective way to recompute awards if market conditions change materially in the course of litigation; (d) satisfaction of the “parity in risk” principal which requires consistent treatment of uncertainty in cash flows and discount rate, which is violated by using an arbitrary average of three-month T-bill rates if inflation is embedded in lost earnings; and (e) a theoretically investible stream of cash flows that can be maturity matched against projected lost earnings.