On Irreversible Investment and Discounting: An Arbitrage Pricing Approach

23 Pages Posted: 28 Jan 2008 Last revised: 31 Mar 2008

See all articles by Jacco Thijssen

Jacco Thijssen

University of York - The York Management School

Abstract

This paper presents a unified approach to valuing investment projects under uncertainty, based on stochastic discount factors, by linking optimal stopping theory to the no-arbitrage principle in asset pricing. An investment threshold for the case where the discount factor and the project's cash-flow both follow a geometric Brownian motion is derived. Comparative statics of the investment trigger are obtained adding to and clarifying on the uncertainty - investment debate. Finally, three different ways are illustrated to obtain discount factors: no-arbitrage, CAPM, and representative agent analysis. The link between the characteristics of these different approaches and the optimal investment policy is studied.

Keywords: Real options, Discount factors

JEL Classification: G31

Suggested Citation

Thijssen, Jacco, On Irreversible Investment and Discounting: An Arbitrage Pricing Approach. Available at SSRN: https://ssrn.com/abstract=1088013 or http://dx.doi.org/10.2139/ssrn.1088013

Jacco Thijssen (Contact Author)

University of York - The York Management School ( email )

Sally Baldwin Buildings
Heslington
York, North Yorkshire YO10 5DD
United Kingdom

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