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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. Bertola, Giuseppe, 1998. "Irreversible investment," Research in Economics, Elsevier, vol. 52(1), pages 3-37, March.
  2. Pindyck, Robert, 1989. "Irreversibility, uncertainty, and investment," Policy Research Working Paper Series 294, The World Bank.
  3. Ricardo J. Caballero & John V. Leahy, 1996. "Fixed Costs: The Demise of Marginal q," NBER Working Papers 5508, National Bureau of Economic Research, Inc.
  4. Andrew B. Abel & Avinash K. Dixit & Janice C. Eberly & Robert S. Pindyck, 1995. "Options, the Value of Capital, and Investment," NBER Working Papers 5227, National Bureau of Economic Research, Inc.
  5. Dixit, Avinash, 1995. "Irreversible investment with uncertainty and scale economies," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 327-350.
  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. Anders ├╗ksendal, 2000. "Irreversible investment problems," Finance and Stochastics, Springer, vol. 4(2), pages 223-250.
  8. Luis H. R. Alvarez & Erkki Koskela, 2006. "Irreversible Investment under Interest Rate Variability: Some Generalizations," The Journal of Business, University of Chicago Press, vol. 79(2), pages 623-644, March.
  9. Caballero, Ricardo J., 1999. "Aggregate investment," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 12, pages 813-862 Elsevier.
  10. Robert S. Pindyck, 1986. "Irreversible Investment, Capacity Choice, and the Value of the Firm," NBER Working Papers 1980, National Bureau of Economic Research, Inc.
  11. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
  12. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc.
  13. 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.
  14. Luis H. R. Alvarez & Erkki Koskela, 2001. "Wicksellian Theory of Forest Rotation under Interest Rate Variability," CESifo Working Paper Series 606, CESifo Group Munich.
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