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INVESTMENT IRREVERSIBILITY IN GENERAL EQUILIBRIUM: Capital Accumulation, Interest Rates, and the Risk Premium

Listed author(s):
  • Miquel Faig

This paper provides a tractable general equilibrium model that can accommodate shocks and irreversibility constraints both at the firm and at the aggregate level. Under realistic conditions, irreversibility not only prevents capital destruction, but it also promotes capital creation. Moreover, irreversibility depresses risk-free rates, especially in booms, and magnifies risk premia, especially in downturns. In addition to the theoretical analysis, two numerical examples illustrate the quantitative effects of investment irreversibility in the face of either large rare depressions or mild frequent recessions.

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File URL: https://www.economics.utoronto.ca/public/workingPapers/UT-ECIPA-FAIG-97-01.ps
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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number faig-97-01.

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Length: 37 pages
Date of creation: 14 May 1997
Handle: RePEc:tor:tecipa:faig-97-01
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  16. Dow, James Jr. & Olson, Lars J., 1992. "Irreversibility and the behavior of aggregate stochastic growth models," Journal of Economic Dynamics and Control, Elsevier, vol. 16(2), pages 207-223, April.
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  26. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-286, April.
  27. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474, March.
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  31. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March.
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