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Accounting for systematic risk in benefit-cost analysis: a practical approach

Published online by Cambridge University Press:  19 January 2015

Jason Hansen  and
Jonathan Lipow
Jason Hansen
Affiliation:
Naval Postgraduate School – Defense Resources Management Institute, CA, USA
Jonathan Lipow*
Affiliation:
Naval Postgraduate School – Defense Resources Management Institute, CA, USA
*
Jonathan Lipow, Naval Postgraduate School – Defense Resources Management Institute, 699 Dyer Road, Code 64, Monterey, CA, 93933, USA, Tel: +831.656.3233, Fax: +831.656.2139, e-mail: [email protected]
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Abstract

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Circular A-94 specifies how analysts should discount costs and benefits of government projects, and thus how to account for risk. In this paper, we argue that the methods mandated by A-94 properly account for non-systematic and term risk, but not for systematic risk. A numerical example illustrates how improper accounting for systematic risk produces misleading results and social welfare loss. We conclude by proposing a simple modification of A-94’s procedures that would allow analysts to at least partially account for systematic risk.

Keywords

A-94benefit-cost analysisdiscountingrisk
Type
Article
Information
Journal of Benefit-Cost Analysis , Volume 4 , Issue 3 , 01 December 2013 , pp. 361 - 373
Copyright
Copyright © Society for Benefit-Cost Analysis 2013

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