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The Value of Waiting to Invest

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  • Robert L. McDonald
  • Daniel Siegel

Abstract

This paper studies the optimal timing of investment in an irreversible project where the benefits from the project and the investment cost follow continuous-time stochastic processes. The optimal time to invest and an explicit formula for the value of the option to invest are derived. The rule "invest if benefits exceed costs" does not properly account for the option value of waiting.Simulations show that this option value can be significant, and that for surprisingly reasonable parameter values it may be optimal to wait until benefits are twice the investment cost. Finally, we perform comparative static analysis on the valuation formula and on the rule for when to invest.

Suggested Citation

  • Robert L. McDonald & Daniel Siegel, 1982. "The Value of Waiting to Invest," NBER Working Papers 1019, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:1019
    Note: ME
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    References listed on IDEAS

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    1. Douglas A. Greenley & Richard G. Walsh & Robert A. Young, 1981. "Option Value: Empirical Evidence from a Case Study of Recreation and Water Quality," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 96(4), pages 657-673.
    2. Claude Henry, 1974. "Option Values in the Economics of Irreplaceable Assets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 41(5), pages 89-104.
    3. Ingersoll, Jonathan Jr., 1977. "A contingent-claims valuation of convertible securities," Journal of Financial Economics, Elsevier, vol. 4(3), pages 289-321, May.
    4. Ben S. Bernanke, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 98(1), pages 85-106.
    5. Baldwin, Carliss Y. & Meyer, Richard F., 1979. "Liquidity preference under uncertainty: A model of dynamic investment in illiquid opportunities," Journal of Financial Economics, Elsevier, vol. 7(4), pages 347-374, December.
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    1. Holzer, Patrick & Loy, Jens-Peter, 2016. "Messung Des Vermarktungserfolges Bei Marktfruchtbaubetrieben: Wie Groß Sind Die Unterschiede?," 56th Annual Conference, Bonn, Germany, September 28-30, 2016 244893, German Association of Agricultural Economists (GEWISOLA).
    2. Ciżkowicz, Piotr & Rzońca, Andrzej, 2010. "Inflation and corporate investment in selected OECD countries in the years 1960-2005 – an empirical analysis," MPRA Paper 29846, University Library of Munich, Germany.
    3. Alan Marcus, 1987. "Corporate Pension Policy and the Value of PBGC Insurance," NBER Chapters, in: Issues in Pension Economics, pages 49-80, National Bureau of Economic Research, Inc.
    4. Mankan M. Koné & Carl Gaigné & Lota Tamini, 2017. "Duopolistic Competition and Optimal Switching Time from Export to FDI in Uncertainty," CIRANO Working Papers 2017s-23, CIRANO.
    5. Tennert, Julius & Lambert, Marie & Burghof, Hans-Peter, 2017. "Moral hazard in VC finance: More expensive than you thought," Hohenheim Discussion Papers in Business, Economics and Social Sciences 02-2017, University of Hohenheim, Faculty of Business, Economics and Social Sciences.

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