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Irreversible investment and capacity choice with Bayesian learning

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  • Hu, Fan
  • Wu, Yaoyao
  • Zhou, Lei

Abstract

This paper incorporates information incompleteness into the standard capacity choice model. The firm dynamically updates its belief about the expected growth rate based on the realization of demand shocks. First, the firm’s expansion decision becomes more conservative in the dynamic updating case. Moreover, a myopic firm always overestimates the marginal value of capital but underestimates firm value. When we decompose the firm value into the value of assets in place and growth opportunities, dynamic learning significantly increases the value of growth opportunities rather than that of assets in place. Finally, the implications for the user cost of capital is also examined.

Suggested Citation

  • Hu, Fan & Wu, Yaoyao & Zhou, Lei, 2022. "Irreversible investment and capacity choice with Bayesian learning," The North American Journal of Economics and Finance, Elsevier, vol. 63(C).
  • Handle: RePEc:eee:ecofin:v:63:y:2022:i:c:s1062940822001504
    DOI: 10.1016/j.najef.2022.101815
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    References listed on IDEAS

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    More about this item

    Keywords

    Irreversible investment; Capacity choice; Incomplete information; Dynamic learning;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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