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Irreversible Investment under Interest Rate Variability: Some Generalizations

  • Alvarez, Luis H.R.
  • Koskela, Erkki

We study the impact of interest rate and revenue variability on the decision to carry out irreversible investment. We provide a mathematical characterization of the two-dimensional optimal stopping problem and show that interest rate variability has a decelerating or accelerating impact on investment depending on whether the current interest rate is below or above the long-run steady state. Allowing for interest rate volatility decelerates investment by raising both the required exercise premium of the investment opportunity and the value of waiting. Finally, increased revenue volatility is shown to strengthen the negative impact of interest rate volatility and vice versa.

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Paper provided by The Research Institute of the Finnish Economy in its series Discussion Papers with number 841.

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Length: 27 pages
Date of creation: 2003
Date of revision:
Handle: RePEc:rif:dpaper:841
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  1. Ioannis Karatzas & Fridrik M. Baldursson, 1996. "Irreversible investment and industry equilibrium (*)," Finance and Stochastics, Springer, vol. 1(1), pages 69-89.
  2. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Wiley Blackwell, vol. 61(2), pages 223-46, April.
  3. Cabalero, R.J., 1997. "Aggregaete Investment," Working papers 97-20, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
  5. Robert S. Pindyck, 1986. "Irreversible Investment, Capacity Choice, and the Value of the Firm," NBER Working Papers 1980, National Bureau of Economic Research, Inc.
  6. Pindyck, Robert, 1989. "Irreversibility, uncertainty, and investment," Policy Research Working Paper Series 294, The World Bank.
  7. Caballero, Ricardo J, 1991. "On the Sign of the Investment-Uncertainty Relationship," American Economic Review, American Economic Association, vol. 81(1), pages 279-88, March.
  8. Bernanke, Ben S, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, MIT Press, vol. 98(1), pages 85-106, February.
  9. Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1992. "Waiting to Invest: Investment and Uncertainty," The Journal of Business, University of Chicago Press, vol. 65(1), pages 1-29, January.
  10. Bertola, Giuseppe, 1998. "Irreversible investment," Research in Economics, Elsevier, vol. 52(1), pages 3-37, March.
  11. Nickell, Stephen J, 1974. "On the Role of Expectations in the Pure Theory of Investment," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 1-19, January.
  12. Nickell, Stephen J, 1974. "On Expectations, Government Policy and the Rate of Investment," Economica, London School of Economics and Political Science, vol. 41(163), pages 241-55, August.
  13. Merton, Robert C, 1975. "An Asymptotic Theory of Growth under Uncertainty," Review of Economic Studies, Wiley Blackwell, vol. 42(3), pages 375-93, July.
  14. Henry, Claude, 1974. "Investment Decisions Under Uncertainty: The "Irreversibility Effect."," American Economic Review, American Economic Association, vol. 64(6), pages 1006-12, December.
  15. Cukierman, Alex, 1980. "The Effects of Uncertainty on Investment under Risk Neutrality with Endogenous Information," Journal of Political Economy, University of Chicago Press, vol. 88(3), pages 462-75, June.
  16. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  17. Yaozhong Hu & Bernt Øksendal, 1998. "Optimal time to invest when the price processes are geometric Brownian motions," Finance and Stochastics, Springer, vol. 2(3), pages 295-310.
  18. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc.
  19. Demers, Michel, 1991. "Investment under Uncertainty, Irreversibility and the Arrival of Information over Time," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 333-50, April.
  20. Anders ûksendal, 2000. "Irreversible investment problems," Finance and Stochastics, Springer, vol. 4(2), pages 223-250.
  21. Baldwin, Carliss Y, 1982. " Optimal Sequential Investment When Capital Is Not Readily Reversible," Journal of Finance, American Finance Association, vol. 37(3), pages 763-82, June.
  22. Luis H. R. Alvarez & Erkki Koskela, 2001. "Wicksellian Theory of Forest Rotation under Interest Rate Variability," CESifo Working Paper Series 606, CESifo Group Munich.
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