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Understanding Investment Irreversibility In General Equilibrium

  • Miquel Faig

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 [1997]), 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.

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File URL: http://www.economics.utoronto.ca/public/workingPapers/UT-ECIPA-FAIG-98-01.pdf
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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number faig-98-01.

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Length: 33 pages
Date of creation: 11 Jul 1998
Date of revision:
Handle: RePEc:tor:tecipa:faig-98-01
Contact details of provider: Postal: 150 St. George Street, Toronto, Ontario
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  1. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-48, September.
  2. Caplin, Andrew & Leahy, John V, 1993. "Sectoral Shocks, Learning, and Aggregate Fluctuations," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 777-94, October.
  3. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, volume 1, number 5474.
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