Inflation Risk as Determinant of the Discount Rate in Tort Settlements

The yield on long-term bonds has been cited as the most frequently used discount rate in tort settlements. Returns from long-term bonds do not change as interest rates rise in response to unanticipated inflation. Investors (plaintiffs) are thereby exposed to inflation risk - the possibility that future investment returns may not keep pace with future increases in prices and wages. Future returns from short-term instruments will likely rise as a result of unanticipated inflation. Since short-term instruments reduce exposure to inflation risk, the yield on short-term financial instruments is the appropriate rate to use when discounting to present value.