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Review of Middle East Economics and Finance

Ed. by Dibeh, Ghassan / Assaf, Ata / Cobham, David / Hakimian, Hassan / Henry, Clement M.

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Investment Under Uncertainty in Egypt: A Real-Options Approach

Alaa El-Shazly1

1Department of Economics, Cairo University

Citation Information: Review of Middle East Economics and Finance. Volume 2, Issue 2, Pages 51–60, ISSN (Online) 1475-3693, DOI: https://doi.org/10.2202/1475-3693.1025, August 2004

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This paper provides a numerical analysis of investment under uncertainty using Egyptian data. It is based on the theoretical foundations that the irreversibility of investment decisions and the uncertainty about their future rewards create a value to waiting for new information before the firm commits resources and incurs unrecoverable costs. Accordingly, the optimal investment policy of the firm balances the value of waiting for new information with the cost of postponing the investment in terms of forgone return. The analytical framework uses diffusion-jump processes to model uncertainty over time and shows that the value of waiting increases with the degree of uncertainty. As a consequence, uncertainty increases the hurdle rate to investment and can become a powerful deterrent to investors.

Keywords: diffusion-jump processes; real options; optimal stopping

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