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Valuing an investment project using no-arbitrage and the alpha-maxmin criteria: From Knightian uncertainty to risk

Author

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  • Yann Braouezec

    (LEM - Lille économie management - UMR 9221 - UA - Université d'Artois - UCL - Université catholique de Lille - Université de Lille - CNRS - Centre National de la Recherche Scientifique)

  • Robert Joliet

    (LEM - Lille économie management - UMR 9221 - UA - Université d'Artois - UCL - Université catholique de Lille - Université de Lille - CNRS - Centre National de la Recherche Scientifique)

Abstract

We consider a two-period irreversible investment decision problem in which the firm can either invest in period 0 or in period 1. The firm is assumed to be able to specify a set of three scenarios or more but not a probability measure. Assuming the option to wait is valued with the no-arbitrage principle, when the firm makes use of the criteria α-maxmin, we show the firm ends up with a known probability measure that assigns a positive probability to three or four scenarios only.

Suggested Citation

  • Yann Braouezec & Robert Joliet, 2019. "Valuing an investment project using no-arbitrage and the alpha-maxmin criteria: From Knightian uncertainty to risk," Post-Print hal-02504260, HAL.
    • Handle: RePEc:hal:journl:hal-02504260
    DOI: 10.1016/j.econlet.2019.03.007
    Note: View the original document on HAL open archive server: https://hal.science/hal-02504260
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    References listed on IDEAS

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    1. Johanna Etner & Meglena Jeleva & Jean‐Marc Tallon, 2012. "Decision Theory Under Ambiguity," Journal of Economic Surveys, Wiley Blackwell, vol. 26(2), pages 234-270, April.
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    More about this item

    Keywords

    Knightian uncertainty; Investment decision; Option to wait; No-arbitrage; α -maxmin;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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