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Finite project life and uncertainty effects on investment

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Author Info
Gryglewicz, Sebastian
Huisman, Kuno J.M.
Kort, Peter M.

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Abstract

This paper revisits the important result of the real options approach to investment under uncertainty, which states that increased uncertainty raises the value of waiting and thus decelerates investment. Typically in this literature projects are assumed to be perpetual. However, in today's economy firms face a fast-changing technology environment, implying that investment projects are usually considered to have a finite life. The present paper studies investment projects with finite project life, and we find that, in contrast with the existing theory, investments may be accelerated by increased uncertainty. It is shown that this particularly happens at low levels of uncertainty and when project life is short.

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Publisher Info
Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 32 (2008)
Issue (Month): 7 (July)
Pages: 2191-2213
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Handle: RePEc:eee:dyncon:v:32:y:2008:i:7:p:2191-2213

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  1. Lee, Cheng F. & Wu, Chunchi & Wei, K. C. John, 1990. "The Heterogeneous Investment Horizon and the Capital Asset Pricing Model: Theory and Implications," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(03), pages 361-376, September. [Downloadable!]
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  3. Decamps, Jean-Paul & Mariotti, Thomas, 2004. "Investment timing and learning externalities," Journal of Economic Theory, Elsevier, vol. 118(1), pages 80-102, September. [Downloadable!] (restricted)
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  5. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September. [Downloadable!] (restricted)
  6. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November. [Downloadable!] (restricted)
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  8. Caballero, Ricardo J, 1991. "On the Sign of the Investment-Uncertainty Relationship," American Economic Review, American Economic Association, vol. 81(1), pages 279-88, March. [Downloadable!] (restricted)
  9. Sarkar, Sudipto, 2003. "The effect of mean reversion on investment under uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 377-396, November. [Downloadable!] (restricted)
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  12. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October. [Downloadable!] (restricted)
  13. Thijssen, J.J.J. & Huisman, K.J.M. & Kort, P.M., 2001. "Strategic investment under uncertainty and information spillovers," Discussion Paper 91, Tilburg University, Center for Economic Research. [Downloadable!]
  14. Zeira, Joseph, 1990. "Cost uncertainty and the rate of investment," Journal of Economic Dynamics and Control, Elsevier, vol. 14(1), pages 53-63, February. [Downloadable!] (restricted)
  15. Pawlina, Grzegorz & Kort, Peter M., 2005. "Investment under uncertainty and policy change," Journal of Economic Dynamics and Control, Elsevier, vol. 29(7), pages 1193-1209, July. [Downloadable!] (restricted)
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  16. Guo, Xin & Miao, Jianjun & Morellec, Erwan, 2005. "Irreversible investment with regime shifts," Journal of Economic Theory, Elsevier, vol. 122(1), pages 37-59, May. [Downloadable!] (restricted)
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  1. Ni, Shawn X & Ratti, Ronald A., 2009. "Heterogeneous Parameter Uncertainty and the Timing of Investment during Crisis," Economics Discussion Papers 2009-12, Kiel Institute for the World Economy. [Downloadable!]
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