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Irreversible Investment, Incremental Capital Accumulation, and Price Uncertainty

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Author Info
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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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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Related research
Keywords: Price uncertainty; irreversible investment; incremental capital accumulation.;

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Find related papers by JEL classification:
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis

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  1. 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. [Downloadable!] (restricted)
  2. Ricardo J. Caballero & John V. Leahy, 1996. "Fixed Costs: The Demise of Marginal q," NBER Working Papers 5508, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Andrew B. Abel & Avinash K. Dixit & Janice B. Eberly & Robert S. Pindyck, . "Options, the Value of Capital, and Investment," Rodney L. White Center for Financial Research Working Papers 15-95, Wharton School Rodney L. White Center for Financial Research.
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  4. Bertola, Giuseppe, 1998. "Irreversible investment," Research in Economics, Elsevier, vol. 52(1), pages 3-37, March. [Downloadable!] (restricted)
  5. Luis H.R. Alvarez & Erkki Koskela, 2003. "On Forest Rotation Under Interest Rate Variability," Discussion Papers 840, The Research Institute of the Finnish Economy. [Downloadable!]
  6. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Anders ûksendal, 2000. "Irreversible investment problems," Finance and Stochastics, Springer, vol. 4(2), pages 223-250. [Downloadable!] (restricted)
  8. Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1992. "Waiting to Invest: Investment and Uncertainty," Journal of Business, University of Chicago Press, vol. 65(1), pages 1-29, January. [Downloadable!] (restricted)
  9. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-85, December. [Downloadable!] (restricted)
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  10. Dixit, Avinash, 1995. "Irreversible investment with uncertainty and scale economies," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 327-350. [Downloadable!] (restricted)
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  11. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Alvarez, Luis H. R. & Koskela, Erkki, 2005. "Wicksellian theory of forest rotation under interest rate variability," Journal of Economic Dynamics and Control, Elsevier, vol. 29(3), pages 529-545, March. [Downloadable!] (restricted)
  13. Pindyck, Robert S., 1990. "Irreversibility, uncertainty, and investment," Working papers 3137-90., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
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