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INVESTMENT IRREVERSIBILITY IN GENERAL EQUILIBRIUM: Capital Accumulation, Interest Rates, and the Risk Premium

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Miquel Faig

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Abstract

This paper provides a tractable general equilibrium model that can accommodate shocks and irreversibility constraints both at the firm and at the aggregate level. Under realistic conditions, irreversibility not only prevents capital destruction, but it also promotes capital creation. Moreover, irreversibility depresses risk-free rates, especially in booms, and magnifies risk premia, especially in downturns. In addition to the theoretical analysis, two numerical examples illustrate the quantitative effects of investment irreversibility in the face of either large rare depressions or mild frequent recessions.

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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number faig-97-01.

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Length: 37 pages
Date of creation: 14 May 1997
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Handle: RePEc:tor:tecipa:faig-97-01

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Find related papers by JEL classification:
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

References listed on IDEAS
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.:

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  2. Caplin, Andrew & Leahy, John V, 1993. "Sectoral Shocks, Learning, and Aggregate Fluctuations," Review of Economic Studies, Blackwell Publishing, vol. 60(4), pages 777-94, October. [Downloadable!] (restricted)
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  4. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June. [Downloadable!] (restricted)
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  5. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-48, September. [Downloadable!] (restricted)
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  6. Gregory W. Huffman & Mark A. Wynne, 1995. "The role of intratemporal adjustment costs in a multi-sector economy," Working Papers 95-08, Federal Reserve Bank of Dallas. [Downloadable!]
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  7. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April. [Downloadable!] (restricted)
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  15. Lawrence J. Christiano & Jonas D.M. Fisher, 1995. "Tobin's Q and asset returns: implications for business cycle analysis," Staff Report 200, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  16. Andrew B. Abel & Janice B. Eberly, . "The Effects of Irreversibility and Uncertainty on Capital Accumulation," Rodney L. White Center for Financial Research Working Papers 21-95, Wharton School Rodney L. White Center for Financial Research.
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  17. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Blackwell Publishing, vol. 61(2), pages 223-46, April. [Downloadable!] (restricted)
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  18. Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Mark, 1990. "Mean Reversion in Equilibrium Asset Prices," NBER Working Papers 2762, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  22. 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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  23. Marcelo Veracierto, 1997. "Plant level irreversible investment and equilibrium business cycles," Discussion Paper / Institute for Empirical Macroeconomics 115, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  24. Lawrence J. Christiano & Jonas D.M. Fisher, 1994. "Algorithms for solving dynamic models with occasionally binding constraints," Working Paper Series, Macroeconomic Issues 94-6, Federal Reserve Bank of Chicago.
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Cited by:
(explanations, 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.)

  1. Valerie A. Ramey & Matthew D. Shapiro, 1998. "Displaced Capital," NBER Working Papers 6775, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Marcelo L. Veracierto, 2002. "Plant-Level Irreversible Investment and Equilibrium Business Cycles," American Economic Review, American Economic Association, vol. 92(1), pages 181-197, March. [Downloadable!]
    Other versions:
  3. Miquel Faig & Pauline Shum, 1997. "INVESTMENT IRREVERSIBILITY AND ENDOGENOUS FINANCING: An Evaluation of the Corporate Tax Effects," Working Papers faig-97-02, University of Toronto, Department of Economics. [Downloadable!]
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