Irreversible investment and discounting: an arbitrage pricing approach |
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Authors: | Jacco J J Thijssen |
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Institution: | (1) Technology Management and Financial Engineering, Polytechnic University, Six MetroTech Center, 11201 Brooklyn, NY, USA |
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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, two different
ways to obtain discount factors are illustrated: spanning assets and representative agent analysis. The link between the characteristics
of these different approaches and the optimal investment policy is clarified. |
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Keywords: | |
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