Cognitive Limitations and Investment “Myopia”*

Abstract

ABSTRACT Optimization of investment decisions in an uncertain and dynamically evolving environment is difficult due to the limitations of the decision‐maker's cognitive capacity. Thus, actual investment decisions may deviate from the dynamically optimal decision rule. This paper investigates how a potential investment rule bias affects the expected payoff from a project that has an uncertain development time and an uncertain completion cost. The result shows that the presence of a potential bias in the adopted decision rule dissipates project value and that the dissipating effect is greater for a longer term project if the completion cost is an increasing function of the time to completion.