CHAPTER 15
The Derivation of the
NPV Probability
Distribution of Risky
Investments with
Autoregressive Cash
Flows
Jean-Paul Paquin,∗Annick Lambert and Alain Charbonneau
15.1 INTRODUCTION
Frederick Hillier’s (1963) seminal paper was probably the first to propose
the use of probabilistic information to assess risk in the process of capital
budgeting. However, such an approach to investment decision was short-
lived when Sharpe published his 1964 paper, supplemented by Lintner’s
(1965) and Mossin’s (1966) articles, thus setting the conceptual ground for
what was to become the modern capital asset pricing model (CAPM). Even
Hertz’s (1964) simulation methodology and Wagle’s (1967) statistical analy-
sis of risk in capital investment projects did not fare better. In fact, all the
∗I would like to thank Dr F.-E. Racicot for his useful comments and encouragement.278