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INVESTMENT DECISION UNDER UNCERTAINTY: THEORY AND PRACTICE

by James C T Mao, John F Helliwell
Journal of Finance ()
  • ISSN: 0022-1082

Abstract

This paper is based on the thesis that by studying financial theory and financial practice in relation to one another, we may find ways in which both can be improved. The paper will first present a theory of investment decision under uncertainty which incorporates the following ideas: (1) a firm should choose portfolios rather than projects, (2) investment and financing decisions must be made simultaneously if the optimal program is to be chosen, (3) the risk attributable to an investment should be measured by its contribution to the total risk of a firm viewed in a market context, (4) a firm should trade off risk and return at the market-established rate of substitution, and (5) investors view security returns in real terms rather than in monetary terms. The paper will then present the results of three case studies investigating the actual making of investment decisions. We shall examine the disparity between the theory and practice of investment decisions, and suggest some reasons why the sophisticated techniques developed by theorists are not fully implemented in practice. Finally, the paper will indicate some of the lines along which future research should be directed. [ABSTRACT FROM AUTHOR]

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