Real Options and Risk Aversion

21 Pages Posted: 17 Jul 2003 Last revised: 28 Sep 2008

See all articles by Julien Hugonnier

Julien Hugonnier

Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Erwan Morellec

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Date Written: September 1, 2007

Abstract

In the standard real options approach to investment under uncertainty, agents formulate optimal policies under the assumptions of risk neutrality or complete financial markets. Although these assumptions are crucial to the implications of the approach, they are not particularly relevant to most real-world environments where agents face incomplete markets and are exposed to undiversifiable risks. In this paper we extend the real options approach to incorporate risk aversion for a general class of utility functions. We show that risk aversion provides an incentive for the investor to delay investment and leads to a significant erosion in project values.

Keywords: Risk aversion, Real options, Investment timing

JEL Classification: G31, E22

Suggested Citation

Hugonnier, Julien and Morellec, Erwan, Real Options and Risk Aversion (September 1, 2007). Swiss Finance Institute Research Paper. Available at SSRN: https://ssrn.com/abstract=422600 or http://dx.doi.org/10.2139/ssrn.422600

Julien Hugonnier

Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL Dorigny
Extranef
Lausanne, CH-1015
Switzerland

HOME PAGE: http://sfi.epfl.ch/hugonnier

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Erwan Morellec (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

College of Management
Extranef Quartier UNIL-Dorigny
1015 Lausanne, CH-1015
Switzerland

HOME PAGE: http://sfi.epfl.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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