Irreversibility, uncertainty and investment
Most investment expenditures have two important characteristics. First, they are largely irreversible; the firm cannot disinvest, so the expenditures are sunk costs. Second, they can be delayed, allowing the firm to wait for new information about prices, costs, and other mark...
| Main Author: | |
|---|---|
| Format: | Working Paper |
| Published: |
MIT Center for Energy and Environmental Policy
Research
2009
|
| Online Access: | http://hdl.handle.net/1721.1/50140 |
| _version_ | 1811089988552491008 |
|---|---|
| author | Pindyck, Robert S. |
| author_facet | Pindyck, Robert S. |
| author_sort | Pindyck, Robert S. |
| collection | MIT |
| description | Most investment expenditures have two
important characteristics. First, they are largely irreversible; the firm cannot disinvest,
so the expenditures are sunk costs. Second, they can be delayed, allowing the firm to wait
for new information about prices, costs, and other marketing conditions before committing
resources. An emerging literature has shown that this has important implications for
investment decisions, and for the determinants of investment spending. Irreversible
investment is especially sensitive to risk, whether with respect to future cash flows,
interest rates, or the ultimate cost of the investment. Thus if a policy goal is to
stimulate investment, stability and credibility may be more important than tax incentives or
interest rates. This paper presents some simple models of irreversible investment, and shows
how optimal investment rules and the valuation of projects and firms can be obtained from
contingent claims analysis, or alternatively from dynamic programming. It demonstrates some
strengths and limitations of the methodology, and shows how the resulting investment rules
depend on various parameters that come from the market environment. It also reviews a number
of results and insights that have appeared in the literature recently, and discusses
possible policy implications. |
| first_indexed | 2024-09-23T14:29:10Z |
| format | Working Paper |
| id | mit-1721.1/50140 |
| institution | Massachusetts Institute of Technology |
| last_indexed | 2024-09-23T14:29:10Z |
| publishDate | 2009 |
| publisher | MIT Center for Energy and Environmental Policy
Research |
| record_format | dspace |
| spelling | mit-1721.1/501402019-04-11T05:55:19Z Irreversibility, uncertainty and investment Pindyck, Robert S. Most investment expenditures have two important characteristics. First, they are largely irreversible; the firm cannot disinvest, so the expenditures are sunk costs. Second, they can be delayed, allowing the firm to wait for new information about prices, costs, and other marketing conditions before committing resources. An emerging literature has shown that this has important implications for investment decisions, and for the determinants of investment spending. Irreversible investment is especially sensitive to risk, whether with respect to future cash flows, interest rates, or the ultimate cost of the investment. Thus if a policy goal is to stimulate investment, stability and credibility may be more important than tax incentives or interest rates. This paper presents some simple models of irreversible investment, and shows how optimal investment rules and the valuation of projects and firms can be obtained from contingent claims analysis, or alternatively from dynamic programming. It demonstrates some strengths and limitations of the methodology, and shows how the resulting investment rules depend on various parameters that come from the market environment. It also reviews a number of results and insights that have appeared in the literature recently, and discusses possible policy implications. Supported by the M.I.T.'s Center for Energy Policy Research and the World Bank. Supported by the National Science Foundation. 2009-12-15T23:52:30Z 2009-12-15T23:52:30Z 1990 Working Paper 90-007 http://hdl.handle.net/1721.1/50140 28596048 Working paper (Massachusetts Institute of Technology. Center for Energy Policy Research) ; MIT-CEPR 90-007. 67 p application/pdf MIT Center for Energy and Environmental Policy Research |
| spellingShingle | Pindyck, Robert S. Irreversibility, uncertainty and investment |
| title | Irreversibility, uncertainty and investment |
| title_full | Irreversibility, uncertainty and investment |
| title_fullStr | Irreversibility, uncertainty and investment |
| title_full_unstemmed | Irreversibility, uncertainty and investment |
| title_short | Irreversibility, uncertainty and investment |
| title_sort | irreversibility uncertainty and investment |
| url | http://hdl.handle.net/1721.1/50140 |
| work_keys_str_mv | AT pindyckroberts irreversibilityuncertaintyandinvestment |