Untangling the Present Value Discount Rate in the Competitive Market Context

The present value discount rate is about the investor, the expected market rate of return on his best alternative asset (BAA), his opportunity cost of buying a subject asset (not the subject's rate of return, subject owner's/seller's cost of capital, nor the required rate of return on an investment in the subject). In the competitive market context, the set of alternative assets, from which he selects his BAA, is not limited to assets similar to the subject. The absence of trade barriers and accompanying high capital mobility enables bona fide consideration of non-similar assets from all segments of the broader market. Rational investment behavior, manifested in ownership of a well-diversified portfolio of 20-to-30 assets in equal dollar positions, demarcates him to be “in the market” for assets of equal dollar value to those in his portfolio. The subject's value defines his implicit wealth level to be at least 20-to-30 times the subject's value, earning him sufficient interest, dividends, and occasional capital gains to live on, rendering his BAA a passive-ownership publicly-traded asset. Regardless of whether the BAA's competitive expected rate of return includes a risk premium, competitive forces — reflecting the Principle of Substitution's unimpeded operation — eliminate arbitrage opportunities and equalize expected rates of return across assets, including the BAA's, at the mid-point between the representative well-diversified portfolio's expected rate of return and risk-free rate. An objective data analysis of Exchange Traded Funds from 1980-2017 calculates expected competitive market rates of return not outside the 2.75% to 3.25% range