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Fixed Investment and Capital Flows: A Real Options Approach

Author

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  • Mr. Jorge A Chan-Lau
  • Mr. Peter B. Clark

Abstract

This paper draws a link between international capital flows and the real options approach to investment by extending a model of real estate investment. It explains gradual investment, investment booms, and investment during recessions and emphasizes sunk costs, uncertainty, and the value of waiting. The optimal waiting time increases as foreign borrowing becomes more expensive because higher returns are required to cover the sunk costs of investing. The lower the initial level of profitability, the more likely investment will be sequential; conversely, a relatively high initial rate of return will be associated with simultaneous investment.

Suggested Citation

  • Mr. Jorge A Chan-Lau & Mr. Peter B. Clark, 1998. "Fixed Investment and Capital Flows: A Real Options Approach," IMF Working Papers 1998/125, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:1998/125
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    File URL: http://www.imf.org/external/pubs/cat/longres.aspx?sk=2719
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    Cited by:

    1. Joshua R. Hendrickson, 2017. "Interest rates and investment coordination failures," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 30(4), pages 493-515, December.
    2. Gauvin, L. & McLoughlin, C. & Reinhardt, D., 2013. "Policy Uncertainty Spillovers to Emerging Markets - Evidence from Capital Flows," Working papers 435, Banque de France.

    More about this item

    Keywords

    WP; interest rate; present discounted value; capital stock; borrowing cost; rate of return; capital flows; irreversible investment; interest rate spread; strategic behavior; investment activity; investment boom; investment decision; cost of capital; Stocks; Competition; Foreign direct investment; Emerging and frontier financial markets; Asia and Pacific;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F39 - International Economics - - International Finance - - - Other

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