TY - UNPB

T1 - Risk Aversion, Price Uncertainty and Irreversible Investments

AU - van den Goorbergh, R.W.J.

AU - Huisman, K.J.M.

AU - Kort, P.M.

N1 - Pagination: 20

PY - 2003

Y1 - 2003

N2 - This paper generalizes the theory of irreversible investment under uncertainty by allowing for risk averse investors in the absence of com-plete markets.Until now this theory has only been developed in the cases of risk neutrality, or risk aversion in combination with complete markets.Within a general setting, we prove the existence of a unique critical output price that distinguishes price regions in which it is optimal for a risk averse investor to invest and price regions in which one should refrain from investing.We use a class of utility functions that exhibit non-increasing absolute risk aversion to examine the e ects of risk aversion, price uncertainty, and other parameters on the optimal investment decision.We nd that risk aversion reduces investment, particularly if the investment size is large.Moreover, we nd that a rise in price uncertainty increases the value of deferring irreversible investments.This e ect is stronger for high levels of risk aversion.In addition, we provide, for the rst time, closed-form comparative statics formulas for the risk neutral investor.

AB - This paper generalizes the theory of irreversible investment under uncertainty by allowing for risk averse investors in the absence of com-plete markets.Until now this theory has only been developed in the cases of risk neutrality, or risk aversion in combination with complete markets.Within a general setting, we prove the existence of a unique critical output price that distinguishes price regions in which it is optimal for a risk averse investor to invest and price regions in which one should refrain from investing.We use a class of utility functions that exhibit non-increasing absolute risk aversion to examine the e ects of risk aversion, price uncertainty, and other parameters on the optimal investment decision.We nd that risk aversion reduces investment, particularly if the investment size is large.Moreover, we nd that a rise in price uncertainty increases the value of deferring irreversible investments.This e ect is stronger for high levels of risk aversion.In addition, we provide, for the rst time, closed-form comparative statics formulas for the risk neutral investor.

KW - risk

KW - prices

KW - uncertainty

KW - investment

KW - options

KW - incomplete markets

M3 - Discussion paper

VL - 2003-119

T3 - CentER Discussion Paper

BT - Risk Aversion, Price Uncertainty and Irreversible Investments

PB - Finance

CY - Tilburg

ER -