Testing the Option Vakue Theory of Irreversible Investment
AbstractThis paper statistically tests the option theory of irreversible investment under uncertainty. Using contingent claims valuation, we derive the value of options to invest in capacity, where the projects are endogenous to the economic circumstances prevailing at the investment date. We then test whether capacity investment decisions made by Canadian copper mines are compatible with the trigger price implied by the theory. The results speak strongly in favor of option theory as a theory of real investment. Our model explains both investment size and timing satisfactorily, from a statistical, and from an economic, point of view, and numerical simulations with a mean-reverting process suggest that the results do not depend crucially on the price being assumed to follow a geometric Brownian motion. Nous etablissons par la methode des actifs contingents la valeur de l'option d'effectuer des investissements irrÃ©versibles rÃ©els qui sont sensibles aux paramÃ¨tres Ã©conomiques prÃ©valant au moment de la dÃ©cision. Nous testons ensuite si des mines de cuivre canadiennes choisissent bien d'effectuer leurs investissements en capacitÃ© de production au moment oÃ¹ le prix du cuivre atteint le niveau critique impliquÃ© par la thÃ©orie. Les rÃ©sultats sont fortement en faveur de celle-ci. Le modÃ¨le explique tant la taille que la date des investissements, d'une maniÃ¨re statistiquement et Ã©conomiquement satisfaisantes; des simulations avec un processus de retour Ã la moyenne indiquent que ces rÃ©sultats ne dÃ©pendent pas de faÃ§on cruciale de l'hypothÃ¨se que le prix suit un processus brownien gÃ©omÃ©trique.
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Bibliographic InfoPaper provided by Universite Aix-Marseille III in its series G.R.E.Q.A.M. with number 95b04.
Length: 32 pages
Date of creation: 1995
Date of revision:
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Postal: G.R.E.Q.A.M., (GROUPE DE RECHERCHE EN ECONOMIE QUANTITATIVE D'AIX MARSEILLE), CENTRE DE VIEILLE CHARITE, 2 RUE DE LA CHARITE, 13002 MARSEILLE.
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Other versions of this item:
- Harchaoui, Tarek M & Lasserre, Pierre, 2001. "Testing the Option Value Theory of Irreversible Investment," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(1), pages 141-66, February.
- Tarek M. Harchaoui & Pierre Lasserre, 1995. "Testing the Option Value Theory of Irreversible Investment," CIRANO Working Papers 95s-41, CIRANO.
- Tarek M. Harchaoui & Pierre Lasserre, 1999. "Testing the Option Value Theory of Irreversible Investment," Cahiers de recherche du DÃ©partement des sciences Ã©conomiques, UQAM 9905, Université du Québec à Montréal, Département des sciences économiques.
- Tarek M. Harchaoui & Pierre Lasserre, 1999. "Testing the Option Value Theory of Irreversible Investment," CIRANO Working Papers 99s-35, CIRANO.
- D92 - Microeconomics - - Intertemporal Choice - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
- G1 - Financial Economics - - General Financial Markets
- L72 - Industrial Organization - - Industry Studies: Primary Products and Construction - - - Mining, Extraction, and Refining: Other Nonrenewable Resources
- Q31 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Demand and Supply; Prices
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