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Investment decisions with finite-lived collars

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  • Adkins, Roger
  • Paxson, Dean
  • Pereira, Paulo J.
  • Rodrigues, Artur

Abstract

The duration of most collar arrangements provided by governments to encourage early investment in infrastructure, renewable energy facilities, or other projects with social objectives are finite, not perpetual. We extend the previous literature on collar-style arrangements by providing an analytical solution for the idle and active values, as well as the investment triggers, for projects where collars are either finite-lived or retractable. What is the difference between these types of arrangements with their perpetual counterpart? Lots, including different vega signs, and substantially different values for different current price levels. Often, finite and retractable collars justify earlier investment timing than perpetual collars. In general, we demonstrate that the finite-lived and retractable versions have a significant impact on optimal behavior, relative to the perpetual case. An important consideration when negotiating the floors, ceilings, and duration (or signalling the expected duration) of a finite or a retractable collar is the current price level of the output and its expected volatility over the life of the contract.

Suggested Citation

  • Adkins, Roger & Paxson, Dean & Pereira, Paulo J. & Rodrigues, Artur, 2019. "Investment decisions with finite-lived collars," Journal of Economic Dynamics and Control, Elsevier, vol. 103(C), pages 185-204.
    • Handle: RePEc:eee:dyncon:v:103:y:2019:i:c:p:185-204
    DOI: 10.1016/j.jedc.2019.04.008
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    Cited by:

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    More about this item

    Keywords

    Finite collars; Perpetual collars; Retractable collars; Investment opportunities;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • Q48 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Government Policy

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