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The Value of Waiting to Invest

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  • Robert L. McDonald
  • Daniel Siegel
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    Abstract

    This paper studies the optimal timing of investment in an irreversible project where the benefits from the project and the investment cost follow continuous-time stochastic processes. The optimal time to invest and an explicit formula for the value of the option to invest are derived. The rule "invest if benefits exceed costs" does not properly account for the option value of waiting.Simulations show that this option value can be significant, and that for surprisingly reasonable parameter values it may be optimal to wait until benefits are twice the investment cost. Finally, we perform comparative static analysis on the valuation formula and on the rule for when to invest.

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    File URL: http://www.nber.org/papers/w1019.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1019.

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    Date of creation: Mar 1987
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    Handle: RePEc:nbr:nberwo:1019

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    References

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    1. Ben S. Bernanke, 1980. "Irreversibility, Uncertainty, and Cyclical Investment," NBER Working Papers 0502, National Bureau of Economic Research, Inc.
    2. Ingersoll, Jonathan Jr., 1977. "A contingent-claims valuation of convertible securities," Journal of Financial Economics, Elsevier, vol. 4(3), pages 289-321, May.
    3. Greenley, Douglas A & Walsh, Richard G & Young, Robert A, 1981. "Option Value: Empirical Evidence from a Case Study of Recreation and Water Quality," The Quarterly Journal of Economics, MIT Press, vol. 96(4), pages 657-73, November.
    4. Baldwin, Carliss Y. & Meyer, Richard F., 1979. "Liquidity preference under uncertainty: A model of dynamic investment in illiquid opportunities," Journal of Financial Economics, Elsevier, vol. 7(4), pages 347-374, December.
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    Cited by:
    1. Ciżkowicz, Piotr & Rzońca, Andrzej, 2010. "Inflation and corporate investment in selected OECD countries in the years 1960-2005 – an empirical analysis," MPRA Paper 29846, University Library of Munich, Germany.

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