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Irreversibility, uncertainty, and investment

  • Pindyck, Robert

Despite its importance to economic growth and the evolution of market structure, the investment behavior of firms, industries, and countries remains poorly understood. This paper has several objectives. First, it reviews some basic models of irreversible investment to illustrate the option-like characteristics of investment opportunities, and to show how optimal investment rules can be obtained from methods of option pricing, or alternatively from dynamic programming. Second, it discusses the implication of irreversibility for the empirical analysis of investment behavior. Finally, it discusses briefly some of the implications that the irreversibility of investment may have for policy. For example, policies that stabilize prices or exchange rates may be effective ways of stimulating investment.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 294.

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Date of creation: 31 Oct 1989
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Handle: RePEc:wbk:wbrwps:294
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  27. Geske, Robert & Shastri, Kuldeep, 1985. "Valuation by Approximation: A Comparison of Alternative Option Valuation Techniques," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(01), pages 45-71, March.
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  37. Lam, Pok-sang, 1989. "Irreversibility and consumer durables expenditures," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 135-150, January.
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  40. Fisher, Anthony C. & Hanemann, W. Michael, 1987. "Quasi-option value: Some misconceptions dispelled," Journal of Environmental Economics and Management, Elsevier, vol. 14(2), pages 183-190, June.
  41. Octavio A. F. Tourinho., 1979. "The Option Value of Reserves of Natural Resources," Research Program in Finance Working Papers 94, University of California at Berkeley.
  42. McDonald, Robert L & Siegel, Daniel R, 1985. "Investment and the Valuation of Firms When There Is an Option to Shut Down," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 331-49, June.
  43. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
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  46. Evans, Paul, 1984. "The Effects on Output of Money Growth and Interest Rate Volatility in the United States," Journal of Political Economy, University of Chicago Press, vol. 92(2), pages 204-22, April.
  47. Van Wijnbergen, Sweder, 1985. "Trade reform, aggregate investment and capital flight : On credibility and the value of information," Economics Letters, Elsevier, vol. 19(4), pages 369-372.
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