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Investment under uncertainty with a zero lower bound on interest rates

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  • Dotsis, George

Abstract

This paper examines irreversible investment decisions when the interest rate is stochastic and constrained by a zero lower bound. In contrast to the commonly found negative relationship between investment and uncertainty, it is shown that the presence of a lower bound on interest rates induces an asymmetric effect of interest rate uncertainty on investment decision. When the interest rate is low an increase in interest rate volatility decreases the value of waiting and increases investment but when the interest rate is high an increase in interest rate volatility increases the value of waiting and decreases investment.

Suggested Citation

  • Dotsis, George, 2020. "Investment under uncertainty with a zero lower bound on interest rates," Economics Letters, Elsevier, vol. 188(C).
    • Handle: RePEc:eee:ecolet:v:188:y:2020:i:c:s0165176520300082
    DOI: 10.1016/j.econlet.2020.108954
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    References listed on IDEAS

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    1. Carmona, Julio & Leon, Angel, 2007. "Investment option under CIR interest rates," Finance Research Letters, Elsevier, vol. 4(4), pages 242-253, December.
    2. Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1992. "Waiting to Invest: Investment and Uncertainty," The Journal of Business, University of Chicago Press, vol. 65(1), pages 1-29, January.
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    4. Jing Cynthia Wu & Fan Dora Xia, 2016. "Measuring the Macroeconomic Impact of Monetary Policy at the Zero Lower Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(2-3), pages 253-291, March.
    5. Viatcheslav Gorovoi & Vadim Linetsky, 2004. "Black's Model of Interest Rates as Options, Eigenfunction Expansions and Japanese Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 14(1), pages 49-78, January.
    6. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    7. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    8. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(4), pages 627-627, November.
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    Cited by:

    1. Boqiang Lin & Siquan Wang, 2023. "Mechanism analysis of the influence of oil price uncertainty on strategic investment of renewable energy enterprises," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(4), pages 4176-4193, October.
    2. Salisu, Afees A. & Vo, Xuan Vinh, 2021. "The behavior of exchange rate and stock returns in high and low interest rate environments," International Review of Economics & Finance, Elsevier, vol. 74(C), pages 138-149.

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    More about this item

    Keywords

    Irreversible investment decisions; Zero lower bound; Shadow interest rate;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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