More on Bernanke's 'Bad News Principle'

Abstract

The role that Bernanke's Bad News Principle plays in the modern theory of investment under uncertainty is analyzed. The analysis shows that the actual investment dilemma is that by delaying investment firms trade-off a higher present value of earnings for a lower present value of the investment cost, in contrast to previous interpretations of this dilemma. The economic interpretation of the Smooth Pasting Condition is clarified too and found to be representing the trade-off mentioned above. It is also shown how investment triggers stay intact despite changes in the profit process, if the changes are restricted to the range of sufficiently high profits.

Keywords: Investment, Uncertainty, Option Value, Competition

JEL Classification: D41, D81