The Value of Waiting and the Theory of Investment Under Uncertainty(With an Application to Kyoto)

Patrick Georges

Working Papers-Department of Finance Canada from Department of Finance Canada

Abstract: This paper applies real option theory to demonstrate that increased uncertainty in the economic environment due to the Kyoto protocol generates additional inertia in investment decisions which are not taken into account in "traditional" (e.g., Computable General Equilibrium) models. Thus, if Kyoto were to increase only the volatility of cash flows (revenues), the modeller who neglects the option value of waiting, inherent in investment decisions under uncertainty, would tend to underestimate the negative impact of Kyoto on investment. On the other hand, if Kyoto implies a fall in the level of expected revenues, a modeller who neglects the option value of waiting would tend to overestimate the negative impact of Kyoto on investment. If Kyoto is modelled as a mix of lower level of expected revenues and higher volatility of revenues, it could be the case that the two types of errors due to the omission of the option value of waiting cancel out, however, this would generally not be the case.

Ce papier utilise la théorie des options réelles pour démontrer qu’un environnement économique plus incertain dû au Protocole de Kyoto pourrait générer des inerties supplémentaires dans les décisions d’investissement qui ne sont pas prises en compte dans les modèles traditionnels (e.g., modèles d’équilibre général calculable). Le modélisateur qui néglige la valeur d’option d’attente inhérente aux décisions d’investissement sous incertitude, sous-estimerait l’impact négatif de Kyoto sur les investissements, si le seul impact de Kyoto était d’accroître la volatilité des revenus. D’autre part, si Kyoto implique une baisse des revenus attendus, un modélisateur qui néglige la valeur d’option d’attente surestimerait l’impact négatif de Kyoto sur l’investissement. Si Kyoto est modélisé comme une combinaison de niveau de revenus plus bas et de volatilité de revenus plus élevée, il se peut que les deux types d’erreurs s’annulent, mais ce ne sera généralement pas le cas.

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