Irreversible investment, ambiguity and equity default swaps

Xiaolin Tang and Zhaojun Yang

Applied Economics Letters, 2018, vol. 25, issue 18, 1301-1305

Abstract: We study the impact of ambiguity on the pricing and timing of the option to invest. There is a funding gap to undertake the investment, which is covered by entering into an equity-for-guarantee swap. Our model predicts that the more ambiguity-averse the agents, the less the option value, the later the investment and the higher the guarantee cost and the leverage. If the entrepreneur is more ambiguity-averse than the insurer, the investment threshold slightly rises as the perceived ambiguity increases, and on the contrary, if the entrepreneur is less ambiguity-averse than the insurer, the investment threshold increases sharply as the perceived ambiguity rises.

Date: 2018
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DOI: 10.1080/13504851.2017.1420866

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