The Timing and Scale of Investment Under Uncertainty
This paper studies optimal investment in sunk assets for a firm facing uncertain future demand and costs. The investment problem is decomposed into decisions over scale and timing which are influenced by convex adjustment costs and the feasibility of delaying investment. The value of the resulting real option to delay behaves as expected in response to increases in demand and cost uncertainty but has new timing and scale interpretations. The larger is the option value, the more capital would be installed if delay were not profitable. The timing of investment, however, is controlled by the expected trajectory of capital prices relative to the firm's discount rate. The analysis also suggests an empirical model for aggregate investment which explains 96% of the variation in real annual investment for Canada over the period (1981-94) using regressors formed from only three variables: business confidence, capital prices and real interest rates.
|Date of creation:||02 Jun 1999|
|Date of revision:|
|Contact details of provider:|| Postal: PO Box 1700, STN CSC, Victoria, BC, Canada, V8W 2Y2|
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- Majd, Saman & Pindyck, Robert S., 1987.
"Time to build, option value, and investment decisions,"
Journal of Financial Economics,
Elsevier, vol. 18(1), pages 7-27, March.
- Saman Majd & Robert S. Pindyck, 1985. "Time to Build, Option Value, and Investment Decisions," NBER Working Papers 1654, National Bureau of Economic Research, Inc.
- Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
- Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
- Andrew B. Abel & Avinash K. Dixit & Janice C. Eberly & Robert S. Pindyck, 1995.
"Options, the Value of Capital, and Investment,"
NBER Working Papers
5227, National Bureau of Economic Research, Inc.
- Andrew B. Abel & Avinash K. Dixit & Janice B. Eberly & Robert S. Pindyck, . "Options, the Value of Capital, and Investment," Rodney L. White Center for Financial Research Working Papers 15-95, Wharton School Rodney L. White Center for Financial Research.
- Abel, Andrew B., 1952-, 1995. "Options, the value of capital, and investment," Working papers 3843-95., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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