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Irreversible Investment, Incremental Capital Accumulation, and Price Uncertainty

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  • Luis H.R. Alvarez E.

    ()
    (Department of Economics, Quantitative Methods in Management, Turku School of Economics)

Abstract

We consider optimal incremental capital accumulation in the presence of investment irreversibility and general price uncertainty. We present a set of general conditions under which the optimal capital accumulation path can be explicitly characterized in terms of an ordinary threshold rule stating that investment is optimal whenever the underlying price exceeds a capital-dependent threshold. We also present a set of general conditions under which increased price volatility expands the region where investment is suboptimal and decreases both the expected cumulative present value of the marginal revenue product of capital and the value of the future expansion options.

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Bibliographic Info

Paper provided by Aboa Centre for Economics in its series Discussion Papers with number 4.

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Length: 34
Date of creation: Apr 2006
Date of revision:
Handle: RePEc:tkk:dpaper:dp4

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Keywords: Price uncertainty; irreversible investment; incremental capital accumulation.;

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  1. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc.
  2. Andrew B. Abel & Avinash Dixit & Janice C. Eberly & Robert S. Pindyck, 1996. "Options, the Value of Capital, and Investment," The Quarterly Journal of Economics, MIT Press, vol. 111(3), pages 753-77, August.
  3. Ricardo J. Caballero & John V. Leahy, 1996. "Fixed Costs: The Demise of Marginal q," Harvard Institute of Economic Research Working Papers 1765, Harvard - Institute of Economic Research.
  4. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc.
  5. Bertola, Giuseppe, 1998. "Irreversible investment," Research in Economics, Elsevier, vol. 52(1), pages 3-37, March.
  6. Alvarez, Luis H R & Koskela, Erkki, 2003. "On Forest Rotation under Interest Rate Variability," International Tax and Public Finance, Springer, vol. 10(4), pages 489-503, August.
  7. Alvarez, Luis H.R. & Koskela, Erkki, 2003. "Irreversible Investment under Interest Rate Variability: Some Generalizations," Discussion Papers 841, The Research Institute of the Finnish Economy.
  8. Luis H. R. Alvarez & Erkki Koskela, 2001. "Wicksellian Theory of Forest Rotation under Interest Rate Variability," CESifo Working Paper Series 606, CESifo Group Munich.
  9. Pindyck, Robert S., 1986. "Irreversible investment, capacity choice, and the value of the firm," Working papers 1802-86., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  10. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
  11. Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1992. "Waiting to Invest: Investment and Uncertainty," The Journal of Business, University of Chicago Press, vol. 65(1), pages 1-29, January.
  12. Avinash Dixit, 1992. "Irreversible investment with uncertainty and scale economies," LSE Research Online Documents on Economics 19372, London School of Economics and Political Science, LSE Library.
  13. Pindyck, Robert S., 1990. "Irreversibility, uncertainty, and investment," Working papers 3137-90., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  14. Anders ├╗ksendal, 2000. "Irreversible investment problems," Finance and Stochastics, Springer, vol. 4(2), pages 223-250.
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