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An Equilibrium Model of Investment Under Uncertainty

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  • Robert Novy-Marx
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    Abstract

    We analyze the optimal investment decisions of heterogeneous firms in a competitive, uncertain environment, characterizing firms' investment strategies explicitly and deriving closed-form solutions for firm value. Real option premia remain significant, and are even unmitigated relative to the standard partial-equilibrium model when both are calibrated to observables. Firms consequently delay investment, choosing not to undertake some positive NPV projects. We compare competitive behavior to that of a strategic monopolist, and quantify the welfare loss associated with monopoly. Finally, the model predicts business cycle dependence on firm returns, with returns negatively skewed during industry expansions but positively skewed in industry recessions. , Oxford University Press.

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    Bibliographic Info

    Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

    Volume (Year): 20 (2007)
    Issue (Month): 5 (2007 29)
    Pages: 1461-1502

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    Handle: RePEc:oup:rfinst:v:20:y:2007:i:5:p:1461-1502

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    Cited by:
    1. Meng, Rujing, 2008. "A patent race in a real options setting: Investment strategy, valuation, CAPM beta, and return volatility," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 32(10), pages 3192-3217, October.
    2. Byron F. Lutz, 2009. "Fiscal amenities, school finance reform and the supply side of the Tiebout market," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2009-18, Board of Governors of the Federal Reserve System (U.S.).
    3. Urban Jermann, 2006. "The Equity Premium Implied by Production," NBER Working Papers 12487, National Bureau of Economic Research, Inc.
    4. Aray, Henry & Gardeazabal, Javier, 2005. "Going Multinational under Exchange Rate Uncertainty," DFAEII Working Papers 2005-05, University of the Basque Country - Department of Foundations of Economic Analysis II.
    5. Iulian Obreja & Chris Telmer, 2009. "Accounting for Low Frequency Variation in Tobin's q," 2009 Meeting Papers, Society for Economic Dynamics 47, Society for Economic Dynamics.
    6. Mellati, Ali, 2008. "Uncertainty and investment in private sector: An analytical argument and a review of the economy of Iran," MPRA Paper 26655, University Library of Munich, Germany.
    7. Toole, Andrew A. & Czarnitzki, Dirk, 2008. "The R&D Investment-Uncertainty Relationship: Do Competition and Firm Size Matter?," ZEW Discussion Papers 08-013, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    8. Christian A. L. Hilber, 2007. "New housing supply and the dilution of social capital," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 3573, London School of Economics and Political Science, LSE Library.
    9. Stefan Kersting & JProf. Silke Huettel & Prof. Martin Odening, 2013. "Structural change in agriculture – an equilibrium approach," EcoMod2013 5300, EcoMod.
    10. Huisman, K.J.M. & Kort, P.M., 2013. "Strategic Capacity Investment Under uncertainty," Discussion Paper, Tilburg University, Center for Economic Research 2013-003, Tilburg University, Center for Economic Research.

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