
A GLUM Primer: The Risk-Adjusted Expecte...
Pfeifer, Phillip E...
A GLUM Primer: The Risk-Adjusted Expected Value
Pfeifer, Phillip E.; Bodily, Samuel E.; Baucells, Manel
QA-0849 | Published August 11, 2016 | 9 pages. Technical Note
Collection: Darden School of Business
Product Details
The purpose of this note is to improve on the expected value criterion by incorporating the willingness and capability to take risk of a rational decision maker. First, this note will review the concept of expected net present value (ENPV) and demonstrate its limitations. Next, we introduce the notion of play capital, or the most one is willing to put at risk in view of one’s life circumstances, goals, and resources. Then, we introduce the general logarithmic utility model (GLUM), a concave transformation that will produce the risk-adjusted ENPV. We demonstrate that the adjusted ENPV is always smaller than the ENPV. Finally, we show that a useful measure of riskiness of a project is the minimum play capital for which the adjusted ENPV is positive.
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