Investment under Uncertainty: Testing the Options Model with Professional Traders

An important class of investment decisions is characterized by unrecoverable sunk costs, resolution of uncertainty through time, and the ability to invest in the future as an alternative to investing today. The options model provides guidance in such settings, including an investment decision rule called the "bad news principle": the downside investment state influences the investment decision whereas the upside investment state is ignored. This study takes a new approach to examining predictions of the options model by using the tools of experimental economics. Our evidence, which is drawn from student and professional trader subject pools, is broadly consonant with the options model.