Expropriation risk, investment decisions and economic sectors

Abstract

We build a Real Options model to assess the importance of private provisionand the impact of expropriation risk on investment timing, investmentvolumes, governmental costs and social welfare. We consider two types ofbusinesses (essential and non essential businesses) and two stages (operatingand investment opportunities), and answer questions regarding three maintopics: the firm's reaction to expropriation risk, the government drivers toexpropriate, and the costs this generates in terms of welfare. We find thatthe firm makes suboptimal investment decisions. When we endogenize thereputational costs of expropriation, results show that the decision of the governmentregarding the level of political risk will largely depend on the typeof business. However, in terms of welfare it is never optimal to expropriate