Risk Aversion, Price Uncertainty and Irreversible Investments
AbstractThis paper generalizes the theory of irreversible investment under uncertainty by allowing for risk averse investors in the absence of com-plete markets.Until now this theory has only been developed in the cases of risk neutrality, or risk aversion in combination with complete markets.Within a general setting, we prove the existence of a unique critical output price that distinguishes price regions in which it is optimal for a risk averse investor to invest and price regions in which one should refrain from investing.We use a class of utility functions that exhibit non-increasing absolute risk aversion to examine the e ects of risk aversion, price uncertainty, and other parameters on the optimal investment decision.We nd that risk aversion reduces investment, particularly if the investment size is large.Moreover, we nd that a rise in price uncertainty increases the value of deferring irreversible investments.This e ect is stronger for high levels of risk aversion.In addition, we provide, for the rst time, closed-form comparative statics formulas for the risk neutral investor.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2003-119.
Date of creation: 2003
Date of revision:
Contact details of provider:
Web page: http://center.uvt.nl
risk; prices; uncertainty; investment; options; incomplete markets;
Find related papers by JEL classification:
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-01-05 (All new papers)
- NEP-CFN-2004-01-05 (Corporate Finance)
- NEP-FIN-2004-01-05 (Finance)
- NEP-MIC-2004-01-05 (Microeconomics)
- NEP-RMG-2004-01-05 (Risk Management)
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Wang, Honglin & Reardon, Thomas, 2008. "Social Learning and Parameter Uncertainty in Irreversible Investment----Evidence from Greenhouse Adoption in Northern China," 2008 Annual Meeting, July 27-29, 2008, Orlando, Florida 6310, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Richard Broekman).
If references are entirely missing, you can add them using this form.