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Investment under Uncertainty
How should firms decide whether and when to invest in new capital equipment, additions to their workforce, or the development of new products? Why have traditional economic models of investment failed to explain the behavior of investment spending in the United States and other countries? In this book, Avinash Dixit and Robert Pindyck provide the first detailed exposition of a new theoretical approach to the capital investment decisions of firms, stressing the irreversibility of most investment decisions, and the ongoing uncertainty of the economic environment in which these decisions are made. In so doing, they answer important questions about investment decisions and the behavior of investment spending.
This new approach to investment recognizes the option value of waiting for better (but never complete) information. It exploits an analogy with the theory of options in financial markets, which permits a much richer dynamic framework than was possible with the traditional theory of investment. The authors present the new theory in a clear and systematic way, and consolidate, synthesize, and extend the various strands of research that have come out of the theory. Their book shows the importance of the theory for understanding investment behavior of firms; develops the implications of this theory for industry dynamics and for government policy concerning investment; and shows how the theory can be applied to specific industries and to a wide variety of business problems.
This new approach to investment recognizes the option value of waiting for better (but never complete) information. It exploits an analogy with the theory of options in financial markets, which permits a much richer dynamic framework than was possible with the traditional theory of investment. The authors present the new theory in a clear and systematic way, and consolidate, synthesize, and extend the various strands of research that have come out of the theory. Their book shows the importance of the theory for understanding investment behavior of firms; develops the implications of this theory for industry dynamics and for government policy concerning investment; and shows how the theory can be applied to specific industries and to a wide variety of business problems.
476 pages, Hardcover
First published January 10, 1994
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About the author
Avinash K. Dixit
24 books126 followersAvinash Kamalakar Dixit (born August 6, 1944 in Bombay, India) is an Indian-American economist. He is currently John J. F. Sherrerd '52 University Professor of Economics Emeritus at Princeton University, Distinguished Adjunct Professor of Economics at Lingnan University (Hong Kong) and Senior Research Fellow at Nuffield College, Oxford.
Dixit received a B.Sc. from Bombay University in 1963 in Mathematics and Physics, a B.A. from Cambridge University in 1965 in Mathematics (Corpus Christi College, First Class), and a Ph.D. in 1968 from the Massachusetts Institute of Technology in Economics.
Dixit has been the John J. F. Sherrerd '52 University Professor of Economics at Princeton University since July 1989. He is also Distinguished Adjunct Professor of Economics at Lingnan University (Hong Kong) and Senior Research Fellow at Nuffield College, Oxford. He previously taught at Massachusetts Institute of Technology, at the University of California, Berkeley, at Balliol College, Oxford and at the University of Warwick. In 1994 Dixit received the first-ever CES Fellow Award from the Center for Economic Studies at the University of Munich.
Dixit has also held visiting scholar positions at the International Monetary Fund and the Russell Sage Foundation. He was President of the Econometric Society in 2001, and was Vice-President (2002) and President (2008) of the American Economic Association. He was elected to the American Academy of Arts and Sciences in 1992 and the National Academy of Sciences in 2005.
With Robert Pindyck he is author of “Investment Under Uncertainty” (Princeton University Press, 1994; ISBN 0691034109), the first text-book exclusively about the real options approach to investments, and described as “a born-classic” in view of its importance to the theory.
(from Wikipedia)
Dixit received a B.Sc. from Bombay University in 1963 in Mathematics and Physics, a B.A. from Cambridge University in 1965 in Mathematics (Corpus Christi College, First Class), and a Ph.D. in 1968 from the Massachusetts Institute of Technology in Economics.
Dixit has been the John J. F. Sherrerd '52 University Professor of Economics at Princeton University since July 1989. He is also Distinguished Adjunct Professor of Economics at Lingnan University (Hong Kong) and Senior Research Fellow at Nuffield College, Oxford. He previously taught at Massachusetts Institute of Technology, at the University of California, Berkeley, at Balliol College, Oxford and at the University of Warwick. In 1994 Dixit received the first-ever CES Fellow Award from the Center for Economic Studies at the University of Munich.
Dixit has also held visiting scholar positions at the International Monetary Fund and the Russell Sage Foundation. He was President of the Econometric Society in 2001, and was Vice-President (2002) and President (2008) of the American Economic Association. He was elected to the American Academy of Arts and Sciences in 1992 and the National Academy of Sciences in 2005.
With Robert Pindyck he is author of “Investment Under Uncertainty” (Princeton University Press, 1994; ISBN 0691034109), the first text-book exclusively about the real options approach to investments, and described as “a born-classic” in view of its importance to the theory.
(from Wikipedia)
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Displaying 1 - 2 of 2 reviews
January 13, 2019
I read this book because I saw it on a few of Taleb's bibliographies and it seemed quite interesting from a superficial level.
The book’s whole premise is that Orthodox Investment Theory is wrong. That theory states that a firm should decide whether or not to invest in a new asset by calculating the NPV (Net Present Value).
The authors argue that NPV is based on implicit assumptions that are not always true.
1. It assumes that the investment is reversible (that it can somehow be undone and expenditures recovered)
2. It assumes that it is a now or never proposition (it cannot be decided later).
In reality irreversibility and delay are characteristics of most investments.
Overall, this book provides a sweeping analysis of options in business, rather than strictly finance (when a firm should invest in X asset, delay investing X asset etc rather than how to think directly about executing call or put options). Nonetheless, options, like so much else that Taleb discusses, is fractal, and because of that there is clearly carry-over knowledge/application to someone like me who is more interested in the personal finance side of optionality.
I also really enjoyed the brief discussions on uncertainty with interest rates and how that should play into investment decisions as well as flexibility vs scale.
To the casual reader: there is A LOT of math + formulas. Some of it I understood, but most of it I didn't. Nonetheless, I am happy I read it because I think I learned a little bit in a relatively short period!
Now back to Infinite Jest...
The book’s whole premise is that Orthodox Investment Theory is wrong. That theory states that a firm should decide whether or not to invest in a new asset by calculating the NPV (Net Present Value).
The authors argue that NPV is based on implicit assumptions that are not always true.
1. It assumes that the investment is reversible (that it can somehow be undone and expenditures recovered)
2. It assumes that it is a now or never proposition (it cannot be decided later).
In reality irreversibility and delay are characteristics of most investments.
Overall, this book provides a sweeping analysis of options in business, rather than strictly finance (when a firm should invest in X asset, delay investing X asset etc rather than how to think directly about executing call or put options). Nonetheless, options, like so much else that Taleb discusses, is fractal, and because of that there is clearly carry-over knowledge/application to someone like me who is more interested in the personal finance side of optionality.
I also really enjoyed the brief discussions on uncertainty with interest rates and how that should play into investment decisions as well as flexibility vs scale.
To the casual reader: there is A LOT of math + formulas. Some of it I understood, but most of it I didn't. Nonetheless, I am happy I read it because I think I learned a little bit in a relatively short period!
Now back to Infinite Jest...
April 30, 2017
Although theoretical, I recommend this to every investor wishing to understand corporate and private investment decision making better.
Too often only the expected value of business decisions is teached in introductory business courses (IRR, payback time, NPV) and the optionality from waiting under uncertainty is not even covered. Rather, it is teached that companies cannot invest in all positive NPV projects, but merely invest in the highest NPV projects available under scarcity of capital.
Reading only the beautiful introduction has a magnificent payoff!
Too often only the expected value of business decisions is teached in introductory business courses (IRR, payback time, NPV) and the optionality from waiting under uncertainty is not even covered. Rather, it is teached that companies cannot invest in all positive NPV projects, but merely invest in the highest NPV projects available under scarcity of capital.
Reading only the beautiful introduction has a magnificent payoff!
Displaying 1 - 2 of 2 reviews