The impact of uncertainty on investment : overview

Abstract

Common consensus in the real option literature is that there is a negative relationship between uncertainty and investment. One of the explanations can be stated that the increased in uncertainty leads to move up the value of waiting and consequently has an adverse effect on investment. Contrary to the existing theory, Sarkar (2000) and Gryglewicz et all (2006) find that this negative relationship is not always correct. The former paper demonstrates that an increase in uncertainty can actually hasten the probability of making an investment under certain condition (when project life is short and level of uncertainty is low) and hence uncertainty has a positive effect on investment. Result of the latter paper is exceptional in the sense that uncertainty may accelerate irreversible investment without building on the convexity of the marginal product of capital. In this thesis, we compare these two papers and investigate whether they support each other or not in the framework of real option theory. Moreover, we made some numerical simulations in order to understand clearly impact of other variables on investment along with uncertainty.