Uncertainty and the trade-off between scale and flexibility in investment
AbstractThis paper analyzes the behavior of a firm that chooses both the scale and timing of its investment. Sensitivity analysis shows that greater demand volatility is associated with the firm investing in larger increments, less frequently. This is in contrast to the conventional wisdom, which is that greater volatility leads to investment in smaller increments, more frequently. Overall, the reduced frequency dominates the greater scale, so that the long-run average rate of investment is a decreasing function of demand volatility. The timing and scale of investment are most sensitive to volatility when there are substantial investment economies of scale.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Economic Dynamics and Control.
Volume (Year): 36 (2012)
Issue (Month): 11 ()
Contact details of provider:
Web page: http://www.elsevier.com/locate/jedc
Investment; Uncertainty; Real options; Economies of scale;
Find related papers by JEL classification:
- D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
- D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Financing, Investment, and Capacity
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
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