This 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.
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Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number
119.
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