Irreversible Investment with Regime Shifts

32 Pages Posted: 3 Dec 2002

See all articles by Xin Guo

Xin Guo

affiliation not provided to SSRN

Jianjun Miao

Boston University - Department of Economics

Erwan Morellec

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Date Written: November 2002

Abstract

Under the real options approach to investment under uncertainty, agents formulate optimal policies under the assumption that firms' growth prospects do not vary over time. This paper proposes and solves a model of investment decisions in which the growth rate and volatility of the decision variable shift between different states at random times. A value-maximizing investment policy is derived such that in each regime the firm's investment policy is optimal and recognizes the possiblity of a regime shift. Under this policy, investment is intermittent and increases with marginal q. Moreover, the rate of investment typically is very small but exhibits some spurts of growth. Implications for marginal q and the user cost of capital are also examined.

Keywords: Investment, Capacity Choice, Regime Shifts, Real Options

JEL Classification: D92, E22, E32

Suggested Citation

Guo, Xin and Miao, Jianjun and Morellec, Erwan, Irreversible Investment with Regime Shifts (November 2002). Available at SSRN: https://ssrn.com/abstract=350860 or http://dx.doi.org/10.2139/ssrn.350860

Xin Guo

affiliation not provided to SSRN

Jianjun Miao

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States
617-353-6675 (Phone)

HOME PAGE: http://people.bu.edu/miaoj

Erwan Morellec (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

College of Management
Extranef Quartier UNIL-Dorigny
1015 Lausanne, CH-1015
Switzerland

HOME PAGE: http://sfi.epfl.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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