How to analyze the investment–uncertainty relationship in real option models?

Diderik Lund

No 03-17, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: The real options tradition originally predicted a decreasing relationship between uncertainty and investment, through the positive effect of higher uncertainty on the trigger level for revenue relative to costs. An opposing effect on the probability of reaching the level has been identified, yielding a total effect with ambiguous sign. This paper makes three points. The “opposing” effect is not always opposing. Systematic risk cannot generally be assumed to increase with volatility. A probability is not the best measure of investment. The sign of the total effect is again ambiguous. This ambiguity is illustrated, depending on specification of model and parameters.

Keywords: investment; uncertainty; real options; stochastic control (search for similar items in EconPapers)
JEL-codes: C61 D92 E22 G31 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2003-11
New Economics Papers: this item is included in nep-cfn and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: How to analyze the investment-uncertainty relationship in real option models? (2005)
Journal Article: How to analyze the investment–uncertainty relationship in real option models? (2005)
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