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The timing and intensity of investment under ambiguity

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  • Ma, Jinrun
  • Niu, Yingjie

Abstract

This paper extends the classic irreversible-investment problem by incorporating Knightian uncertainty to investigate the effect of ambiguity on a firm’s endogenously determined intensity and timing decisions. Compared to preceding studies, we clarify that the introduction of Knightian uncertainty brings a new trade-off between the option effect and ambiguity effect. Concretely, we find that ambiguity results in a U-shaped pattern of the optimal intensity as well as investment threshold against the volatility of the project. Inheriting from the non-monotonic pattern, an increase in risk can actually shorten the expected exercise time and thereby speed up investment in certain situations. However, an increase in ambiguity via a change in the degree of Knigtian uncertainty unambiguously narrows the intensity and accelerates the investment. Finally, robustness for parameterization is examined in this paper as well.

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  • Ma, Jinrun & Niu, Yingjie, 2019. "The timing and intensity of investment under ambiguity," The North American Journal of Economics and Finance, Elsevier, vol. 49(C), pages 318-330.
    • Handle: RePEc:eee:ecofin:v:49:y:2019:i:c:p:318-330
    DOI: 10.1016/j.najef.2019.04.015
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    Cited by:

    1. Shuang Li & Haijun Wang, 2023. "Robust irreversible investment strategy with ambiguity to jump and diffusion risk," International Review of Finance, International Review of Finance Ltd., vol. 23(3), pages 645-665, September.

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    More about this item

    Keywords

    Knightian uncertainty; Risk; Investment timing; Investment intensity; Expected exercise time;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • G3 - Financial Economics - - Corporate Finance and Governance

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