International Journal of Business and Economics Volume 5, No. 2 August, 2006

Irreversibility and Interest Rates

Giuseppe Travaglini

Faculty of Economics, University of Urbino Carlo Bo, Italy

Abstract

The literature on irreversible investment fails to explore the relationship between the present value of alternative strategies and appropriate risk-adjusted interest rates. We attempt to fill this gap by showing that, to avoid arbitrage opportunities, the real option’s rate must be higher than the rate of the immediate strategy. Further, we explain how irreversibility influences the risk-return combination of competing strategies acting as a pure risk factor.

Keywords：irreversibility, real option, risk-adjusted rate.

JEL Classifications：G12, D92, E22.

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