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Political Risk And Irreversible Investment: Theory And An Application To Quebec

Author

Listed:
  • Altug, Sumru
  • Demers, Fanny S
  • Demers, Michel

Abstract

Political risk is widely present in developing but also in developed countries, and stems from a variety of sources. The objective of this paper is twofold. First, we develop a theoretical model to investigate the impact of political risk on irreversible investment. Second, we apply our model to an analysis of the risk of separation of the province of Quebec from the Canadian federation. We consider the investment decisions of a monopolistically competitive firm under uncertainty about demand and about the tax-adjusted price of investment goods. We develop a model of irreversible investment which incorporates learning and a regime switch with time-varying transition probabilities. If a given regime represents a riskier environment in terms of the state of demand or the state of investment price, then attaching a positive probability to a switch to that regime increases the marginal adjustment cost of investing, reduces the expected marginal value of capital, and reduces irreversible investment. We use annual sectoral data for the Quebec economy for the period 1983-1996 to match the behaviour of actual investment with simulated series from our model

Suggested Citation

  • Altug, Sumru & Demers, Fanny S & Demers, Michel, 2000. "Political Risk And Irreversible Investment: Theory And An Application To Quebec," CEPR Discussion Papers 2405, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2405
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    Citations

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    Cited by:

    1. Marie‐Claude Beaulieu & Jean‐Claude Cosset & Naceur Essaddam, 2006. "Political uncertainty and stock market returns: evidence from the 1995 Quebec referendum," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 39(2), pages 621-642, May.
    2. Spanjer, Aldo R., 2009. "Regulatory intervention on the dynamic European gas market--neoclassical economics or transaction cost economics?," Energy Policy, Elsevier, vol. 37(8), pages 3250-3258, August.
    3. Sumru Altug & Michel Demers, 2001. "The Impact of Tax Risk and Persistence on Investment Decisions," Economics Bulletin, AccessEcon, vol. 5(1), pages 1-5.
    4. Tirtiroglu, Dogan & Bhabra, Harjeet S. & Lel, Ugur, 2004. "Political uncertainty and asset valuation: Evidence from business relocations in Canada," Journal of Banking & Finance, Elsevier, vol. 28(9), pages 2237-2258, September.

    More about this item

    Keywords

    Learning; Irreversible investment; Canada; Political risk; Regime shifts; Trends; Quebec investment;
    All these keywords.

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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