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Testing the Option Value Theory of Irreversible Investment

  • Harchaoui, Tarek M
  • Lasserre, Pierre

This article statistically tests the option theory of irreversible investment. Using contingent claims valuation, we derive the value of options to invest in capacity, where the projects are endogenous to the economic circumstances prevailing at the investment date. We then test whether decisions made by Canadian copper mines are compatible with the trigger price implied by the theory. Our model explains investment size and timing satisfactorily from a statistical and an economic point of view; simulations with a mean-reverting process suggest that the results do not depend crucially on the assumption that price follows a geometric Brownian motion.

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Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 42 (2001)
Issue (Month): 1 (February)
Pages: 141-66

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Handle: RePEc:ier:iecrev:v:42:y:2001:i:1:p:141-66
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  1. Gordon, Robert J, 1992. "Measuring the Aggregate Price Level: Implications for Economic Performance and Policy," CEPR Discussion Papers 663, C.E.P.R. Discussion Papers.
  2. George Koutoulas & Lawrence Kryzanowski, 1994. "Integration or Segmentation of the Canadian Stock Market: Evidence Based on the APT," Canadian Journal of Economics, Canadian Economics Association, vol. 27(2), pages 329-51, May.
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