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Options, the Value of Capital, and Investment

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  • Andrew B. Abel
  • Avinash Dixit
  • Janice C. Eberly
  • Robert S. Pindyck

Abstract

Capital investment decisions must recognize the limitations on the firm's ability to later sell or expand capacity. This paper shows how opportunities for future expansion or contraction can be valued as options, how their valuation relates to the q theory of investment, and their effect on the incentive to invest. Generally, the option to expand reduces the incentive to invest, while the option to disinvest raises it. The authors show how these options determine the effect of uncertainty on investment, how they are changed by shifts of the distribution of future profitability, and how the q-theory and option pricing approaches are related. Coauthors are Avinash K. Dixit, Janice C. Eberly, and Robert S. Pindyck. Copyright 1996, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

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Bibliographic Info

Article provided by MIT Press in its journal Quarterly Journal of Economics.

Volume (Year): 111 (1996)
Issue (Month): 3 (August)
Pages: 753-77

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Handle: RePEc:tpr:qjecon:v:111:y:1996:i:3:p:753-77

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  1. Dixit, Avinash K, 1989. "Hysteresis, Import Penetration, and Exchange Rate Pass-Through," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 205-28, May.
  2. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-48, September.
  3. Andrew B. Abel & Janice C. Eberly, 1993. "A Unified Model of Investment Under Uncertainty," NBER Working Papers 4296, National Bureau of Economic Research, Inc.
  4. Robert S. Pindyck, 1986. "Irreversible Investment, Capacity Choice, and the Value of the Firm," NBER Working Papers 1980, National Bureau of Economic Research, Inc.
  5. Fumio Hayashi, 1981. "Tobin's Marginal q and Average a : A Neoclassical Interpretation," Discussion Papers 457, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-38, June.
  7. Leahy, John V, 1993. "Investment in Competitive Equilibrium: The Optimality of Myopic Behavior," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1105-33, November.
  8. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc.
  9. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-57, June.
  10. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 381-402, July.
  11. Mussa, Michael L, 1977. "External and Internal Adjustment Costs and the Theory of Aggregate and Firm Investment," Economica, London School of Economics and Political Science, vol. 44(174), pages 163-78, May.
  12. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
  13. Ben S. Bernanke, 1980. "Irreversibility, Uncertainty, and Cyclical Investment," NBER Working Papers 0502, National Bureau of Economic Research, Inc.
  14. Bartolini, Leonardo, 1993. "Competitive runs : The case of a ceiling on aggregate investment," European Economic Review, Elsevier, vol. 37(5), pages 921-948, June.
  15. Avinash Dixit, 1992. "Investment and Hysteresis," Journal of Economic Perspectives, American Economic Association, vol. 6(1), pages 107-132, Winter.
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