Net Present Value, Duration, and CAPM in Light of Investment Theory: A Comment on Kruk

Thomas Hering,David Rapp,Michael Olbrich

doi:10.35297/qjae.010097

Abstract

In her paper “Corporate Risk Evaluation in the Context of Austrian Business Cycle Theory” recently published in this journal, Joanna Kruk aims to investigate how artificially low interest rates resulting from central bank intervention distort individual investment appraisals and ultimately result in both entrepreneurial misjudgment and resource-wasting malinvestment, fueling the business cycle. She identifies entrepreneurs’ net present value calculations, supposedly unadjusted for risk, as a major issue and suggests adjusting those calculations for risk via both the duration method and the Capital Asset Pricing Model to mitigate the distorting effects. Her argumentation is, however, trapped in neoclassical reasoning and is adversely affected by several misconceptions of the net present value criterion. This comment seeks to reveal those fallacies and explain how to address uncertainty when using net present value calculations to make those calculations part of the solution rather than part of the problem of entrepreneurial misjudgment. The findings are derived from German investment theory rooted in the Austrian school of thought, meaning that they differ compared to those of neoclassical finance theory.

Highlights

In her paper “Corporate Risk Evaluation in the Context of Austrian Business Cycle Theory” recently published in this journal, Kruk (2020) seeks to explain why and how artificially low interest rates brought about by central bank intervention distort individual investment appraisals and eventually lead to clustered entrepreneurial misjudgment, malinvestment, and capital consumption, that is, the business cycle
Economic calculation in general, and entrepreneurial investment decisions in particular, are yet to be thoroughly explored from the perspective of the acting individual and those areas should be stringently investigated owing to their significance for both Austrian theorizing (e.g., Austrian business cycle theory [ABCT]) and practice
Entrepreneurs imagine how the future might look and apply judgment to make their decisions (Klein 2008; Foss and Klein 2012; Packard, Clark, and Klein 2017). Such judgment can certainly be informed by genuine economic calculation; given they are unrelated to the real world, models springing from neoclassicism, in particular the Capital Asset Pricing Model (CAPM), are beyond the scope of any toolbox reasonably applicable for that purpose (Olbrich, Quill, and Rapp 2015; Follert et al 2018)

Summary

INTRODUCTION

In her paper “Corporate Risk Evaluation in the Context of Austrian Business Cycle Theory” recently published in this journal, Kruk (2020) seeks to explain why and how artificially low interest rates brought about by central bank intervention distort individual investment appraisals and eventually lead to clustered entrepreneurial misjudgment, malinvestment, and capital consumption, that is, the business cycle. Entrepreneurs (must) imagine how the future might look and apply judgment to make their (investment) decisions (Klein 2008; Foss and Klein 2012; Packard, Clark, and Klein 2017) Such judgment can certainly be informed by genuine economic calculation; given they are unrelated to the real world, models springing from neoclassicism, in particular the CAPM, are beyond the scope of any toolbox reasonably applicable for that purpose (Olbrich, Quill, and Rapp 2015; Follert et al 2018). While the informational value of duration is in itself fairly limited and essentially confined to theoretical borderline cases, linking it to the finance theory-based CAPM as suggested by Kruk (2020, 145–48) worsens matters In contrast to both NPV and duration, which are decision models, the CAPM is a neoclassical equilibrium model initially established to explain particular market outcomes ex post.

A1 Delta

CONCLUSION