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Irreversible Investment in Stochastically Cyclical Markets

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  • Francisco Ruiz-Aliseda
  • Jianjun Wu

Abstract

This paper presents a new framework for studying irreversible (dis)investment when a market follows a random number of random-length cycles (such as a high-tech product market). It is assumed that a firm facing such market evolution is always unsure about whether the current cycle is the last one, although it can update its beliefs about the probability of facing a permanent decline by observing that no further growth phase arrives. We show that the existence of regime shifts in fluctuating markets suffices for an option value of waiting to (dis)invest to arise, and we provide a marginal interpretation of the optimal (dis)investment policies, absent in the real options literature. The paper also shows that, despite the stochastic process of the underlying variable has a continuous sample path, the discreteness in the regime changes implies that the sample path of the firm’s value experiences jumps whenever the regime switches all of a sudden, irrespective of whether the firm is active or not.
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Suggested Citation

  • Francisco Ruiz-Aliseda & Jianjun Wu, 2012. "Irreversible Investment in Stochastically Cyclical Markets," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 21(3), pages 801-847, September.
  • Handle: RePEc:bla:jemstr:v:21:y:2012:i:3:p:801-847
    DOI: j.1530-9134.2012.00343.x
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    File URL: http://hdl.handle.net/10.1111/j.1530-9134.2012.00343.x
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    References listed on IDEAS

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    1. Decamps, Jean-Paul & Mariotti, Thomas, 2004. "Investment timing and learning externalities," Journal of Economic Theory, Elsevier, vol. 118(1), pages 80-102, September.
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    8. Kyle Bagwell & Robert Staiger, 1997. "Collusion Over the Business Cycle," RAND Journal of Economics, The RAND Corporation, vol. 28(1), pages 82-106, Spring.
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    Cited by:

    1. Rau, Philipp & Spinler, Stefan, 2016. "Investment into container shipping capacity: A real options approach in oligopolistic competition," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 93(C), pages 130-147.
    2. BALLIAUW, Matteo, 2015. "An analysis of entry and exit decisions in shipping markets under uncertainty," Working Papers 2015013, University of Antwerp, Faculty of Applied Economics.
    3. Ruiz-Aliseda, Francisco, 2016. "Preemptive investments under uncertainty, credibility and first mover advantages," International Journal of Industrial Organization, Elsevier, vol. 44(C), pages 123-137.
    4. Talat S. Genc & Georges Zaccour, 2010. "Investment Dynamics: Good News Principle," Working Papers 1006, University of Guelph, Department of Economics and Finance.

    More about this item

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies

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