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Fixed Investments and Capital Flows: A Real Options Approach

Author

Listed:
  • Chan-Lau, Jorge A.

    (International Monetary Fund)

  • Clark, P.B.

    (International Monetary Fund)

Abstract

This paper draws a link between international capital flows and the real options approach to investment by extending the development and cascade model applied by Grenadier (Journal of Finance 51, 1996) to real estate markets. This modified model rationalizes such phenomena as gradual investment, investment booms, and investment during recessions, and it emphasizes the role of sunk costs and uncertainty in determining the timing of investment. We also show that the correlation between capital flows and the spread between the domestic return to capital and the foreign interest rate depends importantly on the source of uncertainty; if the foreign interest rate is stochastic, the correlation is expected to be high, but would be low if the uncertainty affects the domestic rate of return.

Suggested Citation

  • Chan-Lau, Jorge A. & Clark, P.B., 2006. "Fixed Investments and Capital Flows: A Real Options Approach," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 21, pages 816-836.
    • Handle: RePEc:ris:integr:0379
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    Cited by:

    1. Joshua R. Hendrickson, 2017. "Interest rates and investment coordination failures," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 30(4), pages 493-515, December.
    2. Gauvin, L. & McLoughlin, C. & Reinhardt, D., 2013. "Policy Uncertainty Spillovers to Emerging Markets - Evidence from Capital Flows," Working papers 435, Banque de France.

    More about this item

    Keywords

    Fixed investments; Capital flows; Real options;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F39 - International Economics - - International Finance - - - Other

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