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A Stochastic Model of Investment, Marginal q and the Market Value of theFirm

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Andrew B. Abel

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Abstract

This paper presents closed-form solutions for the investment and valuation of a competitive firm with a Cobb-Douglas production function and a constant elasticity adjustment cost function in the presence of stochastic prices for output and inputs. The value of the firm is a linear function of the capital stock. The optimal rate of investmentis an increasing function of the slope of the value function with respect to the capital stock (marginal q). A mean preserving spread of the distribution of future price increases investment. An increase in the scale of the random component of a price can increase, decrease or not affect the rate of investment depending on the sign of the covariance of this price with a weighted average of all prices.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1484.

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Date of creation: Jan 1986
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Handle: RePEc:nbr:nberwo:1484

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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. Pindyck, Robert S., 1980. "Adjustment cost, demand uncertainty, and the behavior of the firm," Working papers 1112-80A., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
  2. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
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  3. 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)
  4. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-34, June. [Downloadable!] (restricted)
  5. 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.
  6. 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)
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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. Richard W. Kopcke, 1995. "Tobin's Q, economic rents, and the optimal stock of capital," Working Papers 95-4, Federal Reserve Bank of Boston. [Downloadable!]
  2. Altshuler, Rosanne & Cummins, Jason, 1997. "Tax Policy and the Dynamic Demand for Domestic and Foreign Capital by Multinational Corporations," Working Papers 97-31, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
    Other versions:
  3. Bronwyn H. Hall, 1988. "The Effect of Takeover Activity on Corporate Research and Development," NBER Working Papers 2191, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Kevin Hassett & Gilbert E. Metcalf, 1994. "Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?," NBER Working Papers 4780, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. M. Menegatti, 2003. "Public Investment and Different Sources of Uncertainty," Economics Department Working Papers 2003-EP02, Department of Economics, Parma University (Italy).
  6. Mailand, Wilhelm, 1998. "Zum Einfluss von Unsicherheit auf die gesamtwirtschaftliche Investitionstatigkeit," Discussion Paper Series 26305, Hamburg Institute of International Economics. [Downloadable!]
  7. Martin Feldstein & Joosung Jun, 1989. "The Effects of Tax Rules on Nonresidential Fixed Investment: Some Preliminary Evidence from the 1980s," NBER Working Papers 1857, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  8. Andrew B. Abel & Janice C. Eberly, 1998. "An Exact Soultion for the Investment and Market Value of a Firm Facing Uncertainty, Adjustment Costs, and Irreversibility," NBER Working Papers 4412, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  9. Elena Bontempi & Roberto Golinelli & Giuseppe Parigi, 2007. "Why demand uncertainty curbs investment: Evidence froma a panel of Italian manufacturing firms," Temi di discussione (Economic working papers) 621, Bank of Italy, Economic Research Department. [Downloadable!]
  10. Michele Moretto & Paolo M. Panteghini & Carlo Scarpa, 2007. "Profit Sharing and Investment by Regulated Utilities: a Welfare Analysis," "Marco Fanno" Working Papers 0059, Dipartimento di Scienze Economiche "Marco Fanno". [Downloadable!]
    Other versions:
  11. Cummins, J.G. & Dey, M., 1998. "Taxation, Investment, and Firm Growth with Heterogeneous Capital," Working Papers 98-07, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
  12. Sergio Lehmann, 1997. "Investment under Uncertainty and Financial Market Development: A q-Theory Approach," Working Papers Central Bank of Chile 17, Central Bank of Chile. [Downloadable!]
  13. Bernard Dumas, 1988. "Pricing Physical Assets Internationally," NBER Working Papers 2569, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  14. Bronwyn Hall, 2006. "R&D, productivity and market value," IFS Working Papers W06/23, Institute for Fiscal Studies. [Downloadable!]
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