Assuming the decision to commit financial crime is rational: NPV>0. How to assess the discount rate? How might one go about assessing the average value or the range of values for that rate?
Dear Karol
You have a most intriguing question. First, which financial crime type are you considering. For example, embezzlement? fraud? theft? extortion? or some other? The required return would be tied to the risk level. How are you measuring risk; Standard deviation of return? Beta of return? Likelihood of being caught by the police? Probability of conviction? Penalty (for example, time in years of prison sentence and/or fine) for conviction? If you commit fraud at a bank is that the same, or different, then defrauding a hotel firm? If you embezzle in Germany is that the same, or different, compared to Brazil? I would think that financial crime is high risk and therefore should have a high required rate of return. A starting point to estimate a required rate of return would be to choose an industry that is illegal, for example the non-pharmaceutical drug industry. Not that organizations in this sector have issued stock that trades on an exchange such that we can measure the financial return performance. However, there must be some available data on the returns from operations (IRRs, internal rates of return). Having consulted a firm entering the medical marijuana industry (which is legal) the project IRRs hover around 60 to 70%. I suggest financial crime should generate a return greater than that, otherwise, an individual could forego the onerous penalties of financial crime and invest in a high risk but legal venture.
It would vary a lot across individuals. In financial markets, there is one discount rate for a paticular level of risk because financial assets are tradable. However, commiting a crime is certainly person-specific, this risk cannot be diversified away, and therefore it would vary hugely across people.
Hello Karol,
Interesting!
For an educated fraudster, there will some incentive to commit financial crime if he/she thinks that the:
(probability of getting away with it) > (probability of getting caught)
If you have the data for the NPV models, you could use the IRR approach to find an effective discount rate.
Regards
Peterson
Peterson, this is not correct. It would be true only if potential benefit from commiting the fraud is eqaul to the cost of getting caught. Moreover, even in this case risk-aversion should not be neglected.
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