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Barriers and Optimal Investment

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  • Jean-Daniel Saphores

    (University of California Irvine)

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    Abstract

    This paper analyzes the impact of different types of barriers on the decision to invest using a simple framework based on stochastic discount factors. Our intuitive approach proposes an alternative to the real options methodology that does not rely on the “smooth-pasting condition.” An application to MacDonald and Siegel’s canonical investment problem (1986) shows that the standard investment threshold over-estimates the optimal threshold when the lower barrier is absorbing and under-estimates it when the lower barrier is reflecting.

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    File URL: http://128.118.178.162/eps/ge/papers/0410/0410009.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series GE, Growth, Math methods with number 0410009.

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    Length: 32 pages
    Date of creation: 13 Oct 2004
    Date of revision:
    Handle: RePEc:wpa:wuwpge:0410009

    Note: Type of Document - pdf; pages: 32
    Contact details of provider:
    Web page: http://128.118.178.162

    Related research

    Keywords: investment; uncertainty; irreversibility; barriers; real options;

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    1. William A. Brock & Michael Rothschild & Joseph E. Stiglitz, 1982. "Stochastic Capital Theory I. Comparative Statics," NBER Technical Working Papers 0023, National Bureau of Economic Research, Inc.
    2. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
    3. Dixit, Avinash & Pindyck, Robert S & Sodal, Sigbjorn, 1999. "A Markup Interpretation of Optimal Investment Rules," Economic Journal, Royal Economic Society, vol. 109(455), pages 179-89, April.
    4. Dumas, Bernard, 1991. "Super contact and related optimality conditions," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 675-685, October.
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