Investment under uncertainty and policy change
Existing real options literature provides relatively little insight into the impact of structural changes of the economic environment on the investment decision of the firm.We propose a method to model the impact of a policy change on investment behavior in which, contrary to the earlier models based on Poisson processes, uncertainty concerning the moment of the change can be explicitly accounted for.Moreover, probabilities of the change depend on the state of the dynamic system, what ensures the consistency of the action of the policy maker. We model the policy change as an upward jump in the (net) investment cost, which is, for instance, caused by a reduction in the investment tax credit.The firm has an incomplete information concerning the trigger value of the process for which the jump occurs.We derive the optimal investment rule maximizing the value of the firm.It is shown that the impact of trigger value uncertainty is non-monotonic: the investment threshold decreases with the trigger value uncertainty for low levels of uncertainty, while the reverse is true for high uncertainty levels.Finally, we present policy implications for the authority that result from the firm's value-maximizing behavior.
(This abstract was borrowed from another version of this item.)
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
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.:
- Lander, Diane M. & Pinches, George E., 1998. "Challenges to the Practical Implementation of Modeling and Valuing Real Options," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 537-567.
- Cherian, Joseph A & Perotti, Enrico C, 1999.
"Option Pricing and Foreign Investment under Political Risk,"
CEPR Discussion Papers
2327, C.E.P.R. Discussion Papers.
- Cherian, Joseph A. & Perotti, Enrico, 2001. "Option pricing and foreign investment under political risk," Journal of International Economics, Elsevier, vol. 55(2), pages 359-377, December.
- Pennings, Enrico, 2000. "Taxes and stimuli of investment under uncertainty," European Economic Review, Elsevier, vol. 44(2), pages 383-391, February.
- Sumru Altug & Michel Demers, 2001. "The Impact of Tax Risk and Persistence on Investment Decisions," Economics Bulletin, AccessEcon, vol. 5(1), pages 1-5.
- Dixit, A., 1988.
"Entry And Exit Decisions Under Uncertainty,"
91, Princeton, Department of Economics - Financial Research Center.
- Kevin A. Hassett & Gilbert E. Metcalf, 1998.
"Investment With Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?,"
Discussion Papers Series, Department of Economics, Tufts University
9823, Department of Economics, Tufts University.
- Hassett, Kevin A & Metcalf, Gilbert E, 1999. "Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?," Economic Journal, Royal Economic Society, vol. 109(457), pages 372-93, July.
- Kevin Hassett & Gilbert E. Metcalf, 1994. "Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?," NBER Working Papers 4780, National Bureau of Economic Research, Inc.
- Mauer, David C. & Ott, Steven H., 1995. "Investment under Uncertainty: The Case of Replacement Investment Decisions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(04), pages 581-605, December.
- Paolo M. Panteghini & Carlo Scarpa, 2003. "Irreversible Investments and Regulatory Risk," CESifo Working Paper Series 934, CESifo Group Munich.
- Marc Baudry, 2000. "Joint Management of Emission Abatement and Technological Innovation for Stock Externalities," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 16(2), pages 161-183, June.
- Lambrecht, Bart & Perraudin, William, 2003. "Real options and preemption under incomplete information," Journal of Economic Dynamics and Control, Elsevier, vol. 27(4), pages 619-643, February.
- Hartman, Richard, 1976. "Factor Demand with Output Price Uncertainty," American Economic Review, American Economic Association, vol. 66(4), pages 675-81, September.
- Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
- 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.
- Naik, Vasanttilak, 1993. " Option Valuation and Hedging Strategies with Jumps in the Volatility of Asset Returns," Journal of Finance, American Finance Association, vol. 48(5), pages 1969-84, December.
When requesting a correction, please mention this item's handle: RePEc:eee:dyncon:v:29:y:2005:i:7:p:1193-1209. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)
If references are entirely missing, you can add them using this form.