Explicit investment rules with time-to-build and uncertainty
AbstractWe establish explicit socially optimal rules for an irreversible investment deci- sion with time-to-build and uncertainty. Assuming a price sensitive demand function with a random intercept, we provide comparative statics and economic interpreta- tions for three models of demand (arithmetic Brownian, geometric Brownian, and the Cox-Ingersoll-Ross). Committed capacity, that is, the installed capacity plus the in- vestment in the pipeline, must never drop below the best predictor of future demand, minus two biases. The discounting bias takes into account the fact that investment is paid upfront for future use; the precautionary bias multiplies a type of risk aversion index by the local volatility. Relying on the analytical forms, we discuss in detail the economic effects.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1406.0055.
Date of creation: May 2014
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Other versions of this item:
- René Aid & Salvatore Federico & Huyen Pham & Bertrand Villeneuve, 2014. "Explicit investment rules with time-to-build and uncertainty," Working Papers, HAL hal-00997994, HAL.
- NEP-ALL-2014-06-07 (All new papers)
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