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Investment under uncertainty and policy change

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  • Pawlina, G.
  • Kort, P.M.

    (Tilburg University)

Abstract

Existing real options literature provides relatively little insight into the impact of structural changes of the economic environment on the investment decision of the firm.We propose a method to model the impact of a policy change on investment behavior in which, contrary to the earlier models based on Poisson processes, uncertainty concerning the moment of the change can be explicitly accounted for.Moreover, probabilities of the change depend on the state of the dynamic system, what ensures the consistency of the action of the policy maker. We model the policy change as an upward jump in the (net) investment cost, which is, for instance, caused by a reduction in the investment tax credit.The firm has an incomplete information concerning the trigger value of the process for which the jump occurs.We derive the optimal investment rule maximizing the value of the firm.It is shown that the impact of trigger value uncertainty is non-monotonic: the investment threshold decreases with the trigger value uncertainty for low levels of uncertainty, while the reverse is true for high uncertainty levels.Finally, we present policy implications for the authority that result from the firm's value-maximizing behavior.

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Bibliographic Info

Paper provided by Tilburg University in its series Open Access publications from Tilburg University with number urn:nbn:nl:ui:12-148455.

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Date of creation: 2004
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Publication status: Published in Journal of Economic Dynamics and Control (2004) v.29, p.1193-1209
Handle: RePEc:ner:tilbur:urn:nbn:nl:ui:12-148455

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Web page: http://www.tilburguniversity.edu/

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  1. Cherian, Joseph A. & Perotti, Enrico, 2001. "Option pricing and foreign investment under political risk," Journal of International Economics, Elsevier, Elsevier, vol. 55(2), pages 359-377, December.
  2. Hassett, Kevin A & Metcalf, Gilbert E, 1999. "Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 109(457), pages 372-93, July.
  3. Lander, Diane M. & Pinches, George E., 1998. "Challenges to the Practical Implementation of Modeling and Valuing Real Options," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 38(3, Part 2), pages 537-567.
  4. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 97(3), pages 620-38, June.
  5. Hartman, Richard, 1976. "Factor Demand with Output Price Uncertainty," American Economic Review, American Economic Association, American Economic Association, vol. 66(4), pages 675-81, September.
  6. Farzin, Y.H. & Huisman, K.J.M. & Kort, P.M., 1998. "Optimal timing of technology adoption," Open Access publications from Tilburg University, Tilburg University urn:nbn:nl:ui:12-74049, Tilburg University.
  7. Mauer, David C. & Ott, Steven H., 1995. "Investment under Uncertainty: The Case of Replacement Investment Decisions," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 30(04), pages 581-605, December.
  8. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, Elsevier, vol. 2(3), pages 225-243, September.
  9. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 101(4), pages 707-27, November.
  10. Lambrecht, Bart & Perraudin, William, 2003. "Real options and preemption under incomplete information," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 27(4), pages 619-643, February.
  11. Pennings, Enrico, 2000. "Taxes and stimuli of investment under uncertainty," European Economic Review, Elsevier, Elsevier, vol. 44(2), pages 383-391, February.
  12. Marc Baudry, 2000. "Joint Management of Emission Abatement and Technological Innovation for Stock Externalities," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 16(2), pages 161-183, June.
  13. Sumru Altug & Michel Demers, 2001. "The Impact of Tax Risk and Persistence on Investment Decisions," Economics Bulletin, AccessEcon, vol. 5(1), pages 1-5.
  14. Paolo M. Panteghini & Carlo Scarpa, 2003. "Irreversible Investments and Regulatory Risk," CESifo Working Paper Series 934, CESifo Group Munich.
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Cited by:
  1. Lambie, Neil Ross, 2010. "Understanding the effect of an emissions trading scheme on electricity generator investment and retirement behaviour: the proposed Carbon Pollution Reduction Scheme," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, Australian Agricultural and Resource Economics Society, vol. 54(2), June.
  2. Graham, Jeffrey, 2011. "Strategic real options under asymmetric information," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 35(6), pages 922-934, June.
  3. Nishide, Katsumasa & Nomi, Ernesto Kazuhiro, 2009. "Regime uncertainty and optimal investment timing," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 33(10), pages 1796-1807, October.
  4. Gryglewicz, S. & Huisman, K.J.M. & Kort, P.M., 2006. "Finite Project Life and Uncertainty Effects on Investment," Discussion Paper, Tilburg University, Center for Economic Research 2006-124, Tilburg University, Center for Economic Research.
  5. Makoto Goto & Katsumasa Nishide & Ryuta Takashima, 2013. "Irreversible Investment under Competition with a Markov Switching Regime," KIER Working Papers, Kyoto University, Institute of Economic Research 861, Kyoto University, Institute of Economic Research.
  6. Wilson, Nathan E., 2012. "Uncertain regulatory timing and market dynamics," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 30(1), pages 102-115.

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