The timing and intensity of investment under ambiguity

Jinrun Ma and Yingjie Niu

The North American Journal of Economics and Finance, 2019, vol. 49, issue C, 318-330

Abstract: This paper extends the classic irreversible-investment problem by incorporating Knightian uncertainty to investigate the effect of ambiguity on a firm’s endogenously determined intensity and timing decisions. Compared to preceding studies, we clarify that the introduction of Knightian uncertainty brings a new trade-off between the option effect and ambiguity effect. Concretely, we find that ambiguity results in a U-shaped pattern of the optimal intensity as well as investment threshold against the volatility of the project. Inheriting from the non-monotonic pattern, an increase in risk can actually shorten the expected exercise time and thereby speed up investment in certain situations. However, an increase in ambiguity via a change in the degree of Knigtian uncertainty unambiguously narrows the intensity and accelerates the investment. Finally, robustness for parameterization is examined in this paper as well.

Keywords: Knightian uncertainty; Risk; Investment timing; Investment intensity; Expected exercise time (search for similar items in EconPapers)
JEL-codes: D8 E2 G3 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:49:y:2019:i:c:p:318-330

DOI: 10.1016/j.najef.2019.04.015

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