Irreversible investment and Knightian uncertainty

Kiyohiko G. Nishimura, Hiroyuki Ozaki

Research output: Contribution to journalArticle

69 Citations (Scopus)

Abstract

When firms make a decision about irreversible investment, they may not have complete confidence about their perceived probability measure describing future uncertainty. They may think other probability measures perturbed from the original one are also possible. Such uncertainty, characterized by not a single probability measure but a set of probability measures, is called "Knightian uncertainty." The effect of Knightian uncertainty on the value of irreversible investment opportunity is shown to be drastically different from that of traditional uncertainty in the form of risk. Specifically, an increase in Knightian uncertainty decreases the value of investment opportunity while an increase in risk increases it.

Original languageEnglish
Pages (from-to)668-694
Number of pages27
JournalJournal of Economic Theory
Volume136
Issue number1
DOIs
Publication statusPublished - 2007 Sep 1

Keywords

  • Irreversible investment
  • Knightian uncertainty
  • Optimal stopping
  • Risk

ASJC Scopus subject areas

  • Economics and Econometrics

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