This book traces the evolution of investment theory from Fisher and Keynes through to modern real options theories about investment under uncertainty. As explained in Chapter 3, Irving Fisher’s mathematical analysis of the rate of return over cost forms the basis of modern orthodox theories that describe the rational, optimizing behaviour of investors. Fisher’s theory is built to describe a world in which the determinants of investment are quantifiable and investment behaviour can be described mathematically. In contrast, Keynes did not believe that reality is always quantifiable, an issue that he analyzes in detail in A Treatise on Probability (1921). His ideas about limits to quantification resonate in The General Theory of Employment, Interest and Money (1936). Whilst Keynes’s concept of the marginal efficiency of capital is analytically similar to Fisher’s rate of return, for Keynes, limits to quantification limit the capacity for rational behaviour under conditions of uncertainty. Within Keynes’s analysis, mathematical tools are of limited use. As a result, real-world investment is often propelled by psychological motivations, such as animal spirits, conventions and herd instincts. The General Theory is an inspired work but it is full of contradictions and it raises as many questions as it answers. But it is path-breaking in terms of the insights it presents about the effects of financial instability and uncertainty on the process of expectations formation that is central to fixed investment behaviour.
KeywordsInvestment Activity User Cost Investor Behaviour Animal Spirit Investment Theory
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