The Timing and Scale of Investment Under Uncertainty

John P. Small ()

No 9906, Econometrics Working Papers from Department of Economics, University of Victoria

Abstract: 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.

Keywords: Investment; timing; scale (search for similar items in EconPapers)
JEL-codes: D21 D92 (search for similar items in EconPapers)
Pages: 20 pages
Date: 1999-06-02
New Economics Papers: this item is included in nep-fin and nep-mic
Note: ISSN 1485-6441
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://www.uvic.ca/socialsciences/economics/_asse ... ometrics/ewp9906.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:vic:vicewp:9906

Access Statistics for this paper

More papers in Econometrics Working Papers from Department of Economics, University of Victoria PO Box 1700, STN CSC, Victoria, BC, Canada, V8W 2Y2. Contact information at EDIRC.
Bibliographic data for series maintained by Kali Moon ().