Gearing investments with uncertainty

Abstract

Purpose

The purpose of this paper is to outline a method for evaluating gearing ratios when the loan rate and the rate of growth of the asset value are subject to severe uncertainty.

Design/methodology/approach

Gearing ratios often are determined without any explicit methodology to deal with uncertainty. A simple system is designed that includes uncertainty in loan and growth rates and Wald's maximin criterion to evaluate options is used. The paper shows its numerical interpretation, provide a nomogram to facilitate its use, and link it to some recent decisions by listed companies.

Findings

The method outlined here provides an explicit mechanism to consider uncertainties in rates that can guard against unanticipated fluctuations in the value of assets, providing a measure of robustness to uncertainty in investments.

Practical implications

The method provides a platform for exploring uncertainties and their consequences and making tradeoffs among alternative investment strategies.

Originality/value

A new method for dealing with uncertainty in gearing ratios will be valuable to investors considering both short‐ and long‐term strategies. The importance of this approach is underlined by recent failures to anticipate market fluctuations and their implications.

Citation

Thompson, C.J. and Burgman, M.A. (2010), "Gearing investments with uncertainty", Journal of Risk Finance, Vol. 11 No. 1, pp. 107-110. https://doi.org/10.1108/15265941011012714