Uncertain dynamics, correlation effects, and robust investment decisions

Christian Flor and Søren Hesel

Journal of Economic Dynamics and Control, 2015, vol. 51, issue C, 278-298

Abstract: We analyze a firm׳s investment problem when the dynamics of project value and investment cost are uncertain. We provide an explicit solution using a robust method for an ambiguity averse firm taking this into account. Ambiguity aversion regarding a common risk factor impacts differently than ambiguity aversion regarding investment cost residual risk. Correlation between project value and investment cost matters; ambiguity aversion regarding common risk can decrease the investment probability only if correlation is positive. Ambiguity aversion regarding residual risk always increases the investment probability. When only project value is risky, volatility can monotonically decrease the investment threshold; this does not hold with the multiple prior method.

Keywords: Real options; Ambiguity; Risk/uncertainty effects; Correlation effects; Investment timing (search for similar items in EconPapers)
JEL-codes: D81 G31 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:51:y:2015:i:c:p:278-298

DOI: 10.1016/j.jedc.2014.10.011

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