If the goal of macroeconomic policy is to stimulate investment, stability and credibility may be. Hirshleifer and riley, 1994, the analytics of uncertainty and information, cambridge up 5. Some recent papers have investigated the effect of uncertainty on real estate investment, with varying proxies for uncertainty and mixed results. In addition, the negative impact of real exchange rate uncertainty on investment is significantly larger in economies that are highly open and in those with less developed financial systems. Uncertainty, irreversibility, and the timing of climate policy anthony c. Investment and exchange rate uncertainty under different. Investment should be undertaken in this case only when the costs of deferring the project exceed the. A note on competitive investment under uncertainty by robert s. Irreversible investment acknowledges that the value of capital may not be fully recoverable. Investment in greek manufacturing under irreversibility.
Sim the board of governors of the federal reserve system jae. Irreversibility, uncertainty, and investment robert pindyck irreversible investment is especially sensitive to such risk factors as volatile exchange rates and uncertainty about tariff structures and future cash flows. Abstract the decision making process in business is prone to risk because uncertainty is inherent in the. A fresh look at investment decisions under cyclical uncertainty abstract the paper studies the interaction between cyclical uncertainty and investment in a stochastic real option framework where demand shifts stochastically between three different states, each with different rates of drift and volatility. Policy uncertainty and corporate investment by huseyin. The effects of irreversibility and uncertainty on capital. Irreversibility is a key feature in models of investment under uncertainty. Pindyck massachusetts institute of technology my thanks to prabhat mehta for his research assistance, and to ben bernanke, vittorio corbo, nalin kulatilaka, robert mcdonald, louis serven, andreas solimano, and two anonymous referees for helpful comments and suggestions. Pdf investment in greek manufacturing under irreversibility.
Bond and domenico lombardi1 authorized for distribution by pier carlo padoan june 2004 abstract this working paper should not be reported as representing the views of the imf. Investment, uncertainty and irreversibility, economics of. Volatility, policy uncertainty, external finance, and. Sep 21, 2007 housing represents a form of irreversible investment. This paper builds on the theory of irreversible choice under uncertainty to give an explanation of cyclical investment fluctuations. Irreversibility, uncertainty, and cyclical investment nber. Dixit and pindyck, 1994, investment under uncertainty. The resulting prediction that the investment uncertainty relation will be more negative. Jun 01, 2004 investment, uncertainty and irreversibility investment, uncertainty and irreversibility khuong ninh, le. Bernankeirreversibility, uncertainty, and cyclical investment. Irreversibility is an important feature in models of investment under uncertainty.
The model emphasizes both a static and a dynamic mechanism that induce pro cyclical reallocation. Irreversibility, uncertainty, and investment by robert s. Fisher department of agricultural and resource economics university of california at berkeley prepared for the conference on the timing of climate change policies. Irreversibility, uncertainty, and cyclical investment ben s. The quarterly journal of economics, volume 98, issue 1, february 1983. Accounting for the influences of global supply and demand within a var garchinmean framework. Bond nuffield college, oxford and institute for fiscal studies jason g.
Uncertainty, irreversibility, and the timing of climate policy. Irreversibility, uncertainty, and cyclical investment by ben s. Cummins division of research and statistics, federal reserve board. A fresh look at investment decisions under cyclical uncertainty yufu chen michael funke cesifo working paper no. Citations of irreversibility, uncertainty, and investment.
The key observation is that, when individual projects are irreversible, agents must make investment timing decisions that trade off the extra returns from early commitment against the benefits of increased information gained by. The paper studies the interaction between cyclical uncertainty and investment in a stochastic real option framework where demand shifts stochastically between two different states, each with different. April 2014 climate adaptation for decisionmakers evaluating. An exact solution for the investment and value of a firm facing uncertainty, adjustment costs, and irreversibility, journal of economic dynamics and control, elsevier, vol. Cyclical uncertainty and physical investment decisions yufu chen department of economic studies. Irreversibility increases the information value of waiting to invest caballero, 1991, causing investment to vary negatively with fluctuations in political uncertainty over time. Environmental risks may comprise the most important policyrelated application of the economics of risk and uncertainty. The key observation is that, when individual projects are irreversible, agents must make investment timing decisions. The basic idea is that uncertainty about a future tax rate creates uncertainty about the pro. Irreversibility, uncertainty and cyclical investment. The literature on irreversible investment under uncertainty has attempted in various. Irreversibility, uncertainty, and cyclical investment by. An overview alao, esther monisola and adebawojo, oladipupo babcock university, ilishan remo,ogun state, nigeria.
Irreversibility, uncertainty and housing investment. Gollier, 2001, the economics of risk and time, mit press 4. Goel, rati ram illinois state university,department of economics,normal,il 617904200,usa received 11 may 2000. The e ects of irreversibility and uncertainty on capital. Evidence from real estate development abstract we examine 1,214 condominium developments in vancouver, canada between 19791998 to identify the extent to which uncertainty delays investment. By applying the option pricing approach it can be shown that in the presence of irreversibility under uncertainty there exist nonnegligible opportunity costs of investing today rather than keeping the option of waiting to invest until new information arrives. Somewhat less obviously, a firm that shuts down a lossmaking plant is also investing. Policy uncertainty, irreversibility, and crossborder. This paper builds on the theory of irreversible choice under uncertainty to give an explanation of cyclical investment. Policy uncertainty, irreversibility, and crossborder flows.
Financing constraints, irreversibility, and investment. Climate adaptation for decisionmakers april 2014 contributors harry clarke, shanti gadde, alain baillie and rod keenan evaluating investment projects under risk and uncertainty key points the timing of investment for infrastructure projects, and the payoffs or costs from delaying these projects, are important. Pindyck uncertainty over future output prices or input costs can affect investment by a risk neutral firm in two opposing ways. Uncertainty, because it increases the value of waiting for new information, retards the current rate of investment. Investment and the persistence of price uncertainty sciencedirect.
Investment in greek manufacturing under irreversibility and uncertainty. The key observation is that, when individual projects are irreversible, agents must make investment timing. More importantly, we find evidence that the relation between policy uncertainty and capital investment is not uniform in the cross section, being significantly stronger for firms with a higher degree of investment irreversibility and for firms which are. The key observation is that, when individual projects are irreversible, agents must make investment. Irreversibility, uncertainty, and cyclical investment abstract the optimal timing of real investment is studied under the assumptions that investment is irreversible and that new information about returns is arriving over time. Economic fluctuations and growth the optimal timing of real investment is studied under the assumptions that investment is irreversible and that new information about returns is arriving over time. Irreversibility, uncertainty, and cyclical investment jstor. Uncertainty, irreversible investment and general equilibrium. Financing constraints, irreversibility, and investment dynamics. Irreversibility, uncertainty, and cyclical investment ideasrepec. Kahneman, slovic and tversky, 1982, judgment under uncertainty. With uncertainty, the threshold return that justifies an irreversible investment. Andrea caggese pompeu fabra university first version. The paper studies the interaction between cyclical uncertainty and investment in a stochastic real option framework where demand shifts stochastically between two different states, each with different rates of drift and volatility.
Because investment is costly to reverse, irreversibility increases the information value of waiting to invest caballero 1991, causing investment to vary negatively with fluctuations in policy uncertainty over time. Pindyck massachusetts institute of technology cambridge, ma 029 march 1990 my thanks to prabhat mehta for his research assistance, and to vittorio. The literature on irreversible investment under uncertainty has attempted in various ways to assess the longrun or average e. Irreversibility and capital budgeting 177 table 1 hurdle rates as % for different combinations of irreversibility and uncertainty irreversibility s uncertainty a 1 0. Monday, april 1, 20 for a while now, comments from financial market participants and business executives have suggested that high levels of uncertainty have been a key reason for the economys sluggish performance during the current business expansion. Volatility, policy uncertainty, external finance, and investment. Many biases in risk assessment and regulation, such as the conservatism bias in risk assessment and the stringent regulation of synthetic chemicals, reflect a form of ambiguity aversion. In our setting the shifts are governed by a twostate markov switching model with constant transition probabilities. We will argue that this neglect explains some of the failures of that. Investment and exchange rate uncertainty under different regimes 557 estud. Risk and uncertainty federal reserve bank of philadelphia. The optimal timing of real investment is studied under the assumptions that investment is irreversible and that new information about returns is. Louis recently examined the reasons for the increased accumulation of cash on corporate balance sheets. Uncertainty, capital investment, and risk management.
Irreversibility, uncertainty, and cyclical investment. It is well known that the irreversibility constraint has two. The nature of investors optimal reactions to events whose implications are resolved over time is a possible explanation of the instability of aggregate investment over the business cycle. Investment, uncertainty and irreversibility an empirical.
Fisher department of agricultural and resource economics university of california at berkeley prepared for the conference on the timing of climate change policies pew center on global climate change october 2001. In this paper we analyze the effects of irreversibility and uncertainty on the expected longrun capital stock taking account of the usercost and hangover effects together. Irreversibility, uncertainty, and cyclical investment the. The key observation is that, when individual projects are irreversible, agents must make investment timing decisions that trade off the extra returns from early commitment against the benefits of increased information gained. Eberlythe effects of irreversibility and uncertainty on capital accumulation. Fixed investment as a share of gross domestic product is the most robust explanatory variable of a countrys growth see, for example, levine and renelt,1992. Investment, uncertainty and irreversibility an empirical study of rice mills in the mekong river delta, vietnam article in economics of transition 122. The real options effect of uncertainty on investment and.
If the uncertainty is likely to be resolved in the nottoodistant future, the. Uncertainty, credit spreads, and investment dynamics. An empirical investigation using data on analysts profits forecasts stephen r. In this book, avinash dixit and robert pindyck provide the first detailed exposition of a new theoretical approach to the capital investment decisions of firms, stressing the irreversibility of most investment decisions, and the ongoing uncertainty of the economic environment in which these decisions are made. The effects of irreversibility and uncertainty on business investments.
Theoretically, increased uncertainty should lower housing investment. Empirically, finding a proxy for uncertainty has proven problematic. Volatility, policy uncertainty, external finance, and investment sumru altugy investment and growth investment decisions occupy a central role among the determinants of growth. Because investment is costly to reverse, irreversibility increases the information value of waiting to invest caballero 1991, causing investment to vary negatively with. Policy uncertainty, irreversibility, and crossborder flows of capital. Housing represents a form of irreversible investment. Investment, uncertainty and irreversibility investment, uncertainty and irreversibility khuong ninh, le.
Uncertainty, irreversible investment and general equilibrium 1 jae w. Uncertainty, irreversibility, and heterogeneous investment dynamics in italian company data prepared by stephen r. Bernanke this paper builds on the theory of irreversible choice under uncertainty to give an explanation of cyclical investment fluctuations. Irreversible investment, real options, and competition. Fiscal policy, macroeconomics and growth august 2009 presented at cesifo venice summer institute, july 2009 an electronic version of the paper may be downloaded. Uncertainty, credit spreads, and investment dynamics simon gilchrist. Investment, labor demand, uncertainty, real options. If the asset rises in value, the payoff from investing rises. Despite its importance to economic growth and the evolution of market structure, the investment behavior of firms, industries, and countries remains poorly understood. Uncertainty and firm level investment in west germany.
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