Real Investments Under Knightian Uncertainty
84 Pages Posted: 27 Feb 2004
Date Written: January 26, 2004
In a model of real investments with Knightian uncertainty, decision makers deviate from expected utility theory by showing excessive risk aversion and focusing on no regret moves. Within the model, a positive net present value is no longer sufficient to ensure that a real investment is undertaken. Furthermore, the value of being able to hedge increases drastically.
The model could explain deviations from the net present value rule in industries where Knightian uncertainty is high. For example, high hurdle rates for venture capital, and stalled investments in several broadband markets are consistent with the model.
JEL Classification: G31, D8, G24
Suggested Citation: Suggested Citation