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A Unified Model of Investment Under Uncertainty

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Author Info
Andrew B. Abel
Janice C. Eberly

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Abstract

This paper extends the theory of investment under certainty to incorporate fixed costs of investment, a wedge between the purchase price and sale price of capital, and potential irreversibility of investment. In this extended framework, investment is a non-decreasing function of q, the shadow price of installed capital. The optimal rate of investment is in one of three regimes (positive, zero, or negative gross investment) depending on the value of q relative to two critical values. In general however, the shadow price q is not directly observable, so we present two examples relating q to observable variables.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 14-93.

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Handle: RePEc:fth:pennfi:14-93

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September. [Downloadable!] (restricted)
  2. Andrew B. Abel & Olivier J. Blanchard, 1983. "An Intertemporal Model of Saving and Investment," NBER Working Papers 0885, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Blackwell Publishing, vol. 61(2), pages 223-46, April. [Downloadable!] (restricted)
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  4. 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. [Downloadable!] (restricted)
  5. Rothschild, Michael, 1971. "On the Cost of Adjustment," The Quarterly Journal of Economics, MIT Press, vol. 85(4), pages 605-22, November. [Downloadable!] (restricted)
  6. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
  7. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-48, September. [Downloadable!] (restricted)
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  8. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February. [Downloadable!] (restricted)
  9. Treadway, Arthur B, 1969. "On Rational Entrepreneurial Behaviour and the Demand for Investment," Review of Economic Studies, Blackwell Publishing, vol. 36(106), pages 227-39, April. [Downloadable!] (restricted)
  10. Caballero, Ricardo J, 1991. "On the Sign of the Investment-Uncertainty Relationship," American Economic Review, American Economic Association, vol. 81(1), pages 279-88, March. [Downloadable!] (restricted)
  11. Lam, Pok-sang, 1989. "Irreversibility and consumer durables expenditures," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 135-150, January. [Downloadable!] (restricted)
  12. Pindyck, Robert S, 1982. "Adjustment Costs, Uncertainty, and the Behavior of the Firm," American Economic Review, American Economic Association, vol. 72(3), pages 415-27, June.
  13. Janice C. Eberly, . "Adjustment of Consumers' Durables Stocks: Evidence from Automobile Purchases," Rodney L. White Center for Financial Research Working Papers 22-91, Wharton School Rodney L. White Center for Financial Research.
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  14. Grossman, Sanford J & Laroque, Guy, 1990. "Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods," Econometrica, Econometric Society, vol. 58(1), pages 25-51, January. [Downloadable!] (restricted)
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  15. Robert E. Lucas & Jr., 1967. "Adjustment Costs and the Theory of Supply," Journal of Political Economy, University of Chicago Press, vol. 75, pages 321. [Downloadable!] (restricted)
  16. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-24, January. [Downloadable!] (restricted)
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