Irreversible Investments under Uncertainty and Inside-ownership. Real Option Approach in a Reduced Form Hazard Model

Abstract

This thesis investigates the probability of making a marginal investment in 33 Swedish Large Cap firms from 2005 to 2015. We use marginal rate of return as a trigger event in an option to delay. This is then examined in a reduced form hazard model using the Black & Scholes option parameters. We observe how uncertainty affects level of investment with different settings of irreversibility, systematic and idiosyncratic risk, industry segments and inside-ownership. Our primary result shows that a 1-percentage unit increase in quarterly volatility would make the probability to make a marginal investment in a high irreversible firm roughly 20 percentage units lower than a firm with lower irreversibility. However, idiosyncratic risk and inside-ownership comes with ambiguous results as well as the results from different industry segments. Consequently, we address the implications of real option theory and incomplete markets.