The Relationship between Uncertainty and Investment under a Mixed-Jump Process

This paper aims to examine the relationship between uncertainty and investment under an unusual jump process. Since earlier studies on real options mostly base their arguments on the assumption of geometric Brownian motion, the study extends the assumption to a jump process and finds that increased uncertainty, in certain situations, may actually encourage investment.. The stochastic processes of interest is mixed diffusion-jump process. A general approach of Monte Carlo simulation is developed to derive optimal investment trigger for the situation that the closed-form solution could not be readily obtained under the assumption of alternative process. The main finding is that the overall effect of uncertainty on investment is interpreted by the probability of investing, and the relationship appears to be an invested U-shaped curve between uncertainty and investment. The implication is that uncertainty does not always discourage investment even under several sources of uncertainty. Furthermore, high-risk projects are not always dominated by low-risk projects because the high-risk projects may have a positive realization effect on encouraging investment.