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

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  • Andrew B. Abel

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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Bibliographic Info

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: Oct 1984
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Publication status: published as Abel, Andrew B. "A Stochastic Model of Investment, Marginal q and the Market Value of the Firm," International Economic Review, Vol. 26, No. 2, June 1985, pp. 305-322.
Handle: RePEc:nbr:nberwo:1484

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  1. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, Elsevier, vol. 3(4), pages 373-413, December.
  2. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 83(3), pages 509-34, June.
  3. Robert E. Lucas & Jr., 1967. "Adjustment Costs and the Theory of Supply," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 75, pages 321.
  4. Pindyck, Robert S., 1980. "Adjustment cost, demand uncertainty, and the behavior of the firm," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 1112-80A., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  5. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  6. Pindyck, Robert S, 1982. "Adjustment Costs, Uncertainty, and the Behavior of the Firm," American Economic Review, American Economic Association, American Economic Association, vol. 72(3), pages 415-27, June.
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Cited by:
  1. Moretto, Michele & Panteghini, Paolo M. & Scarpa, Carlo, 2008. "Profit sharing and investment by regulated utilities: A welfare analysis," Review of Financial Economics, Elsevier, Elsevier, vol. 17(4), pages 315-337, December.
  2. Benavie, Arthur & Grinols, Earl & Turnovsky, Stephen J., 1996. "Adjustment costs and investment in a stochastic endogenous growth model," Journal of Monetary Economics, Elsevier, Elsevier, vol. 38(1), pages 77-100, August.
  3. 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), Bank of Italy, Economic Research and International Relations Area 621, Bank of Italy, Economic Research and International Relations Area.
  4. Martin Feldstein & Joosung Jun, 1987. "The Effects of Tax Rules on Nonresidential Fixed Investment: Some Preliminary Evidence from the 1980s," NBER Chapters, National Bureau of Economic Research, Inc, in: The Effects of Taxation on Capital Accumulation, pages 101-162 National Bureau of Economic Research, Inc.
  5. Bahmani-Oskooee, Mohsen & Hajilee, Massomeh, 2013. "Exchange rate volatility and its impact on domestic investment," Research in Economics, Elsevier, Elsevier, vol. 67(1), pages 1-12.
  6. Bronwyn H. Hall, 1987. "The Effect of Takeover Activity on Corporate Research and Development," NBER Working Papers 2191, National Bureau of Economic Research, Inc.
  7. 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.
  8. H. Youn Kim, 2003. "Intertemporal production and asset pricing: a duality approach," Oxford Economic Papers, Oxford University Press, vol. 55(2), pages 344-379, April.
  9. Meng, Rujing, 2008. "A patent race in a real options setting: Investment strategy, valuation, CAPM beta, and return volatility," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 32(10), pages 3192-3217, October.
  10. Bernard Dumas, 1988. "Pricing Physical Assets Internationally," NBER Working Papers 2569, National Bureau of Economic Research, Inc.
  11. Bronwyn Hall, 2006. "R&D, productivity and market value," IFS Working Papers, Institute for Fiscal Studies W06/23, Institute for Fiscal Studies.
  12. Abel, Andrew B. & Eberly, Janice C., 1997. "An exact solution for the investment and value of a firm facing uncertainty, adjustment costs, and irreversibility," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 21(4-5), pages 831-852, May.
  13. Andrew B. Abel & Janice C. Eberly, 1993. "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.
  14. Caren Sureth, 2002. "Partially Irreversible Investment Decisions and Taxation under Uncertainty: A Real Option Approach," German Economic Review, Verein für Socialpolitik, Verein für Socialpolitik, vol. 3(2), pages 185-221, 05.
  15. M. Menegatti, 2003. "Public Investment and Different Sources of Uncertainty," Economics Department Working Papers, Department of Economics, Parma University (Italy) 2003-EP02, Department of Economics, Parma University (Italy).
  16. Richard W. Kopcke, 1995. "Tobin's Q, economic rents, and the optimal stock of capital," Working Papers, Federal Reserve Bank of Boston 95-4, Federal Reserve Bank of Boston.
  17. Bruno de Oliveira Cruz & Raouf Boucekkine, 2006. "Technological Progress and Investment Microeconomic Foundations and Macroeconomic Implications," Discussion Papers, Instituto de Pesquisa Econômica Aplicada - IPEA 1170, Instituto de Pesquisa Econômica Aplicada - IPEA.

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