Types
EEV can be "real world" or "market consistent". The former takes the best estimate for parameters that is available, whereas the latter uses a slightly constrained set of parameters which are close to best estimate, but which produce results which match market-related hedge costs.
Real-world EEV usually uses a risk discount rate made up of the risk free rate plus a risk margin which reflects the weighted average cost of capital and Beta from the CAPM model. Using company-level economic models clearly reflects a top-down approach to determining the risk discount rate.
Market-consistent EEV makes use of a bottom-up approach for determining the risk discount rate, which produces a number which equals the risk free rate plus an explicit allowance for operational risk and market risk.
Although initially there was an equal use of these two types of EEV, as time passes companies appear to be moving towards the market-consistent approach.
Read more about this topic: European Embedded Value
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