ABSTRACT
Under the neoclassical theory of investment “NTI”, the marginal rate of return on investment is equated with an interest rate. Prior to Keynes “1936”, the NTI was based on the assumption that the future is certain, in which case that interest rate is the risk-free rate. Keynes was, of course, familiar with the NTI, but he argued at great length and very convincingly in Book IV that uncertainty and risk aversion severely limit the empirical relevance of the theory. 1 The neoclassical response involved the answers to two questions: “1” When do the ideal properties of the investment decision under certainty hold under uncertainty and risk aversion? “2” What “market imperfections” would cause the real world to depart from this ideal world? The answer to the first question was “perfectly competitive capital markets” “PCCM”, where there are no taxes, no transaction costs, and equal information for all market participants. The only departure from the NTI was the addition of a risk premium to the risk-free rate. The answers to the second question that were found will be discussed shortly.
