Risk and Foreign Direct Investment - Index of

A Review of Theory Concerning Risk and the Foreign Investment Decision 19
the car relative to the average being insured or sold. More relevantly, it
also occurs when the insured knows more about their level of risk than
their insurers, or the receiver of a loan more about their creditworthiness
than the bank making the loan. Those who are most at risk have
an incentive not only to conceal their risk but to take the relevant
insurance or sell the car, and those who are least at risk have an incentive
to refrain from incurring the costs of the same insurance or to
withdraw the car from the market and sell it privately. There is a
process of self-selection which could subvert the effective operation of
the market.
Even if the same information is available it may be perceived differently
(Tversky and Kahneman 1979). Perception problems may result
from the way a problem is ‘framed’, which often depends on the
context in which the problem first makes its appearance. The shear
quantity of information available makes this likely. There is an abundant
literature showing that individuals do not behave according to the
standard view of what is rational. Market participants do not make decisions
as rational economic men/women, maximising income, utility or
some easily understood maximand. They have neither enough information
nor the capacity to process that information. They may lack the
inclination, in many situations trusting their own gut feeling or intuition
(for an argument in favour of the use of intuition see Mandron
2000: 1012). They may adopt a range of simplifying tricks or heuristic
devices which allow them to impose order on a rather uncertain world
and to frame the relevant problem in a way which makes it easier to
deal with (Moss 2002: 43–34). This framing may be done in terms of the
status quo, or rather aspirations relative to the status quo; information
may be used which is readily available or striking and ambiguous information
rejected or downplayed; or there may be an optimistic bias, a
preference to use good news rather than bad news, for example the tendency
to ignore the possibility of extreme events. There are many such
simple rules used to put the information available into some kind of
working order.
The third assumption is that investment strategies are already given,
that is, the investment decisions of enterprises are determined independently
of financing decisions. All the possible values of a given
project are ‘spanned’ by assets already sold on the capital market
(Dixit and Pindyck 1994: chapter 5). This means that it is possible to
find an asset or to construct a dynamic portfolio of assets, whose price
is perfectly correlated with that of any project because its risk/return
profile can be replicated by those assets. In the simplest case of no