Understanding Investment Irreversibility In General Equilibrium
This paper advances a tractable model designed to understand investment irreversibility in general equilibrium. The tractability of the model allows analytical results which explain the contrast, emphasized in the extant literature (e.g., Coleman ), between the consequences of irreversibility for individual firms and the consequences of irreversibility for the whole economy. In general equilibrium, irreversibility affects both the wealth of consumers and the return on assets. In the model explored, as long as the inter-temporal elasticity of substitution is realistically low (less than one), investment irreversibility not only prevents capital destruction, but it also induces capital creation. Furthermore, under certain conditions, irreversibility raises the risk premium by increasing the variability of both consumption and the market portfolio.
|Date of creation:||11 Jul 1998|
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- Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474, 06-2016.
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- Andrew Caplin & John Leahy, 1993. "Sectoral Shocks, Learning, and Aggregate Fluctuations," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 777-794.
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