Investment Decisions, Net Present Value and Bounded Rationality

Quantitative Finance, Vol. 9, No. 8, pp. 967-979, December 2009

24 Pages Posted: 3 Dec 2007 Last revised: 29 Jan 2010

See all articles by Carlo Alberto Magni

Carlo Alberto Magni

Università degli studi di Modena e Reggio Emilia (UNIMORE) - School of Doctorate E4E (Engineering for Economics-Economics for Engineering)

Date Written: 2009

Abstract

The Net Present Value maximizing model has a respectable ancestry and is considered by most scholars a theoretically sound decision model. In real-life applications, decision makers use the NPV rule, but apply a subjectively determined hurdle rate, as opposed to the allegedly correct opportunity cost of capital. According to a heuristics-and-biases-program approach, this implies that the hurdle-rate rule is a biased heuristic. This papers shows that the hurdle-rate rule may be interpreted as a fruitful strategy of bounded rationality, where several important element are integrated and condensed into an aspiration level. This paper also addresses the issue of a fruitful cooperation between bounded and unbounded rationality, of which the heuristic NPV is one significant example.

Keywords: Finance, investment decisions, Net Present Value, bounded rationality, hurdle rate, heuristic, methodology

JEL Classification: A11, A12, B41, C61, D46, D81, G11, G31, M21

Suggested Citation

Magni, Carlo Alberto, Investment Decisions, Net Present Value and Bounded Rationality (2009). Quantitative Finance, Vol. 9, No. 8, pp. 967-979, December 2009, Available at SSRN: https://ssrn.com/abstract=1049541

Carlo Alberto Magni (Contact Author)

Università degli studi di Modena e Reggio Emilia (UNIMORE) - School of Doctorate E4E (Engineering for Economics-Economics for Engineering) ( email )

Italy

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