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Pursuing the Wrong Options? Adjustment Costs and the Relationship between Uncertainty and Capital Accumulation

  • Bond, Stephen R.

    ()

    (Nuffield College, Department of Economics and Centre for Business Taxation, University of Oxford, UK and Institute for Fiscal Studies)

  • Söderbom, Måns

    ()

    (Department of Economics, School of Business, Economics and Law, Göteborg University)

  • Wu, Guiying

    ()

    (Nanyang Technological University, Singapore)

bel and Eberly (1999) show that the effect of uncertainty on long run capital accumulation is ambiguous in a real options model with irreversible investment. We show that a higher level of uncertainty tends to reduce expected capital stock levels in a model with strictly convex adjustment costs. Simulations suggest that this negative impact of uncertainty on capital accumulation may be substantial. We also provide some intuition for this result.

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File URL: http://hdl.handle.net/2077/22358
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Paper provided by University of Gothenburg, Department of Economics in its series Working Papers in Economics with number 449.

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Length: 11 pages
Date of creation: 17 May 2010
Date of revision:
Handle: RePEc:hhs:gunwpe:0449
Contact details of provider: Postal: Department of Economics, School of Business, Economics and Law, University of Gothenburg, Box 640, SE 405 30 GÖTEBORG, Sweden
Phone: 031-773 10 00
Web page: http://www.handels.gu.se/econ/

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  1. Janice Eberly & Sergio Rebelo & Nicolas Vincent, 2008. "Investment and Value: A Neoclassical Benchmark," Cahiers de recherche 08-03, HEC Montréal, Institut d'économie appliquée.
  2. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc.
  3. Andrew B. Abel, 2002. "On the Invariance of the Rate of Return to Convex Adjustment Costs," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(3), pages 586-601, July.
  4. Andrew B. Abel & Janice B. Eberly, . "The Effects of Irreversibility and Uncertainty on Capital Accumulation," Rodney L. White Center for Financial Research Working Papers 21-95, Wharton School Rodney L. White Center for Financial Research.
  5. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
  6. Hayashi, Fumio & Inoue, Tohru, 1991. "The Relation between Firm Growth and Q with Multiple Capital Goods: Theory and Evidence from Panel Data on Japanese Firms," Econometrica, Econometric Society, vol. 59(3), pages 731-53, May.
  7. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, volume 1, number 5474.
  8. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc.
  9. Nicholas Bloom, 2007. "The Impact of Uncertainty Shocks," NBER Working Papers 13385, National Bureau of Economic Research, Inc.
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