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Investment options and the business cycle

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  • Jovanovic, Boyan

Abstract

This paper extends [R. Mehra, E.C. Prescott, Recursive competitive equilibrium: The case of homogeneous households, Econometrica 48 (1980) 1365-1380] to a production economy with two capital goods. It is an RBC model in which each unit of investment requires a new idea, an 'option.' When options are scarce, new capital is harder to put in place and the value of old capital rises. Thus the stock market and Tobin's Q are negative indexes of intangibles. During a boom, Q rises gradually, as options are used up. Because investment represents an exercise of options, it has an intertemporal substitution tradeoff that is absent from the adjustment-cost model. Equilibrium may be efficient even without markets for knowledge; the stock market may suffice.

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  • Jovanovic, Boyan, 2009. "Investment options and the business cycle," Journal of Economic Theory, Elsevier, vol. 144(6), pages 2247-2265, November.
    • Handle: RePEc:eee:jetheo:v:144:y:2009:i:6:p:2247-2265
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    Cited by:

    1. Shouyong Shi & Christine Tewfik, 2015. "Financial Frictions, Investment Delay, and Asset Market Interventions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(S2), pages 155-196, June.
    2. Nancy Stokey, 2016. "Wait-and See: Investment Options under Policy Uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 21, pages 246-265, July.
    3. Rousakis, Michael, 2012. "Implementation Cycles : Investment-Specific Technological Change and the Length of Patents," The Warwick Economics Research Paper Series (TWERPS) 983, University of Warwick, Department of Economics.
    4. Lesley Welman & Sanette LA Ferreira, 2016. "The co-evolution of Saldanha Bay (town and hinterland) and its Port," Local Economy, London South Bank University, vol. 31(1-2), pages 219-233, February.
    5. Florin O. Bilbiie & Fabio Ghironi & Marc J. Melitz, 2012. "Endogenous Entry, Product Variety, and Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 304-345.
    6. Rousakis, Michael, 2012. "Implementation Cycles: Investment-Specific Technological Change and the Length of Patents," Economic Research Papers 270656, University of Warwick - Department of Economics.
    7. Ohanian, Lee E. & Prescott, Edward C. & Stokey, Nancy L., 2009. "Introduction to dynamic general equilibrium," Journal of Economic Theory, Elsevier, vol. 144(6), pages 2235-2246, November.
    8. Lee, Junghoon, 2016. "The impact of idiosyncratic uncertainty when investment opportunities are endogenous," Journal of Economic Dynamics and Control, Elsevier, vol. 65(C), pages 105-124.
    9. Florin O. Bilbiie & Fabio Ghironi & Marc J. Melitz, 2008. "Monetary Policy and Business Cycles with Endogenous Entry and Product Variety," NBER Chapters, in: NBER Macroeconomics Annual 2007, Volume 22, pages 299-353, National Bureau of Economic Research, Inc.
    10. Levine, Oliver, 2017. "Acquiring growth," Journal of Financial Economics, Elsevier, vol. 126(2), pages 300-319.
    11. Nancy L. Stokey, 2013. "Wait-and-See: Investment Options under Policy Uncertainty," NBER Working Papers 19630, National Bureau of Economic Research, Inc.
    12. Jiaxing You & Ling Lin & Juanjuan Huang & Min Xiao, 2020. "When is cash king? International evidence on the value of cash across the business cycle," Review of Quantitative Finance and Accounting, Springer, vol. 54(3), pages 1101-1131, April.
    13. Nancy Stokey, 2013. "Uncertainty and Investment Options," 2013 Meeting Papers 251, Society for Economic Dynamics.

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    More about this item

    Keywords

    Tobin's Q Adjustment costs Intertemporal substitution;

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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