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Investment Options and the Business Cycle

  • Boyan Jovanovic

This paper extends Lucas (1978) to a production economy with two capital goods. It is an RBC model in which each unit of investment requires a new idea, an "option". When options are scarce, new capital is harder to put in place and the value of old capital rises. Thus the stock market and Tobin's Q are negative indexes of intangibles. During a boom, Q rises gradually, as options are used up. Because investment represents an exercise of options, it has an intertemporal substitution tradeoff that is absent in the adjustment-cost model. Equilibrium may be efficient even without markets for knowledge; the stock market may suffice.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13307.

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Date of creation: Aug 2007
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Publication status: published as Jovanovic, Boyan, 2009. "Investment options and the business cycle," Journal of Economic Theory, Elsevier, vol. 144(6), pages 2247-2265, November.
Handle: RePEc:nbr:nberwo:13307
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