AbstractDespite its important theoretical, empirical and policy implications, sunk-cost hysteresis has not been characterized for the case of model consistent, or rational expectations (previous studies assume that firms believe the forcing variable is generated by some ad hoc, time invariant process such as an iid or Brownian motion process). This omission is significant since if firms do have forward-looking expectations, the existing characterizations cannot be used for empirical testing, or as a guide in developing appropriate econometric techniques. Furthermore, policy conclusions based on such characterizations may be misleading. This paper demonstrates the possibility and characterizes the nature of sunk-cost hysteresis for a broad class of assumptions on the forcing variable process. Most notably this class includes rational or model consistent expectations. Specifically, we show that the firm's problem with a quite general forcing variable process can be reduced to be formally identical to the iid case. Additionally we analytically show that (i) the hysteresis band tends to widen with greater sunk costs, (ii) the effect of greater volatility on the band width depends upon the specific nature of the process generating the uncertainty, and (iii) greater persistence in the shocks has the effect of making well-entrenched firms more likely to exit and of narrowing the band for marginal firms. Lastly we show that the possibility of sunk-cost hysteresis is robust to a number of modifications of the basic sunk cost model.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2911.
Date of creation: Mar 1989
Date of revision:
Note: ITI IFM
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Web page: http://www.nber.org
More information through EDIRC
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.:
- Catherine L. Mann, 1986. "Prices, profit margins, and exchange rates," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jun, pages 366-379.
- Avinash Dixit, 1979.
"A Model of Duopoly Suggesting a Theory of Entry Barriers,"
Bell Journal of Economics,
The RAND Corporation, vol. 10(1), pages 20-32, Spring.
- Dixit, Avinash K., 1978. "A Model of Duopoly Suggesting a Theory of Entry Barriers," The Warwick Economics Research Paper Series (TWERPS) 125, University of Warwick, Department of Economics.
- Bertola, Giuseppe, 1998. "Irreversible investment," Research in Economics, Elsevier, vol. 52(1), pages 3-37, March.
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page. reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.