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The dynamic effects of real options and irreversibility on investment and labour demand

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Author Info
Nicholas Bloom

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Abstract

This paper shows that, contrary to common beliefs, the real options effect of uncertainty plays no role in the long run rate of investment. This is proven for both the standard investment model with Cobb-Douglas production and Brownian motion demand, and also for a broader class of models with multiple lines of capital, labor and general demand stochastics. Real options and irreversibility, however, are shown to play an important role in the short run dynamics of investment and labor demand. Specifically, they reduce the short run response of investment and hiring to current demand shocks, and lead to a lagged response to past demand shocks.

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Publisher Info
Paper provided by Institute for Fiscal Studies in its series IFS Working Papers with number W00/15.

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Length: 34 pp
Date of creation: Jul 2000
Date of revision:
Handle: RePEc:ifs:ifsewp:00/15

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Find related papers by JEL classification:
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
D8 - Microeconomics - - Information, Knowledge, and Uncertainty

References listed on IDEAS
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. Caballero, Ricardo J & Engel, Eduardo M R A & Haltiwanger, John, 1997. "Aggregate Employment Dynamics: Building from Microeconomic Evidence," American Economic Review, American Economic Association, vol. 87(1), pages 115-37, March. [Downloadable!] (restricted)
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  2. Andrew B. Abel & Janice B. Eberly, . "The Effects of Irreversibility and Uncertainty on Capital Accumulation," Rodney L. White Center for Financial Research Working Papers 21-95, Wharton School Rodney L. White Center for Financial Research.
    Other versions:
  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. Sakellaris, Plutarchos, 1994. "A Note on Competitive Investment under Uncertainty: Comment," American Economic Review, American Economic Association, vol. 84(4), pages 1107-12, September. [Downloadable!] (restricted)
  5. Dixit, Avinash, 1997. "Investment and Employment Dynamics in the Short Run and the Long Run," Oxford Economic Papers, Oxford University Press, vol. 49(1), pages 1-20, January. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
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  7. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
  8. Pindyck, Robert S, 1993. "A Note on Competitive Investment under Uncertainty," American Economic Review, American Economic Association, vol. 83(1), pages 273-77, March. [Downloadable!] (restricted)
  9. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October. [Downloadable!] (restricted)
  10. Jaewoo Lee & Kwanho Shin, 2000. "The Role of a Variable Input in the Relationship between Investment and Uncertainty," American Economic Review, American Economic Association, vol. 90(3), pages 667-680, June. [Downloadable!] (restricted)
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  11. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. 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)
  13. Russell Cooper & John Haltiwanger & Laura Power, 1999. "Machine Replacement and the Business Cycle: Lumps and Bumps," American Economic Review, American Economic Association, vol. 89(4), pages 921-946, September. [Downloadable!] (restricted)
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  14. Eberly, Janice C. & Van Mieghem, Jan A., 1997. "Multi-factor Dynamic Investment under Uncertainty," Journal of Economic Theory, Elsevier, vol. 75(2), pages 345-387, August. [Downloadable!] (restricted)
  15. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-85, December. [Downloadable!] (restricted)
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  16. Walter Y. Oi, 1962. "Labor as a Quasi-Fixed Factor," Journal of Political Economy, University of Chicago Press, vol. 70, pages 538. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, 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. Nick Bloom & John Van Reenen & Stephen Bond, 2006. "Uncertainty and Investment Dynamics," NBER Working Papers 12383, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
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