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Investments of uncertain cost

  • Pindyck, Robert S.

I study irreversible investment decisions when projects take time to complete, and are subject to two types of uncertainty over the cost of completion. The first is technical uncertainty, i.e., uncertainty over the amount of time, effort, and materials that will ultimately be required to complete the project, and that is only resolved as the investment proceeds. The second is input cost uncertainty, i.e., uncertainty over the prices and quantities of labor and materials required, and which is external to the firm's investment activity. I derive a simple decision rule that maximizes the firm's value, and I use it to show how these two types of uncertainty have very different effects on investment decisions. As an example. I analyze the decision to start or continue building a nuclear power plant during the 1980's.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 34 (1993)
Issue (Month): 1 (August)
Pages: 53-76

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Handle: RePEc:eee:jfinec:v:34:y:1993:i:1:p:53-76
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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  1. Avinash Dixit, 1992. "Investment and Hysteresis," Journal of Economic Perspectives, American Economic Association, vol. 6(1), pages 107-132, Winter.
  2. Zeira, Joseph, 1987. "Investment as a Process of Search," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 204-10, February.
  3. Robert S. Pindyck, 1990. "Irreversibility, Uncertainty, and Investment," NBER Working Papers 3307, National Bureau of Economic Research, Inc.
  4. N. Gregory Mankiw, 1986. "Consumer Spending and the After-Tax Real Interest Rate," NBER Working Papers 1991, National Bureau of Economic Research, Inc.
  5. Martin L. Weitzman & Whitney Newey & Michael Rabin, 1981. "Sequential R&D Strategy for Synfuels," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 574-590, Autumn.
  6. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
  7. Saman Majd & Robert S. Pindyck, 1987. "The Learning Curve and Optimal Production Under Uncertainty," NBER Working Papers 2423, National Bureau of Economic Research, Inc.
  8. Bernanke, Ben S, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, MIT Press, vol. 98(1), pages 85-106, February.
  9. Roberts, Kevin & Weitzman, Martin L, 1981. "Funding Criteria for Research, Development, and Exploration Projects," Econometrica, Econometric Society, vol. 49(5), pages 1261-88, September.
  10. 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.
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