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Testing the Option Value Theory of Irreversible Investment

  • Tarek M. Harchaoui
  • Pierre Lasserre

This paper statistically tests the theory of irreversible investment under uncertainty. Using dynamic programming and contingent claims valuation alternatively, 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 capacity investment decisions made by Canadian copper mines are compatible with the theory. The result speak strongly in favor of option theory as a theory of real investment; in particular, we provide a test which rejects the Net Present Value criterion, and our model explains both investment size and timing satisfactorily from a statistical and from an economic point of view. En recourrant tour à tour à la programmation dynamique et à la méthode des actifs contigents, nous établissons la valeur de l'option d'effectuer des investissements irréversibles réels qui sont sensibles aux paramètres économiques prévalant au moment de la décision. Nous testons ensuite si des investissements en capacité de production effectués par des mines de cuivre canadiennes sont conformes aux implications de la théorie. Les résultats sont fortements en faveur de celle-ci; nos données rejettent le critère de la valeur actuelle nette et le modèle explique tant la taille que la date des investissements d'une manière statistiquement et économiquement satisfaisante.

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File URL: http://www.cirano.qc.ca/files/publications/95s-41.pdf
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Paper provided by CIRANO in its series CIRANO Working Papers with number 95s-41.

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Length: 54 pages
Date of creation: 01 Sep 1995
Date of revision:
Handle: RePEc:cir:cirwor:95s-41
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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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