Irreversible Investment in Stochastically Cyclical Markets
51 Pages Posted: 10 Mar 2007
Date Written: March 6, 2007
Abstract
This paper presents a new framework for studying irreversible (dis)investment when a market follows a random number of random-length cycles (such as a high-tech product market). It is assumed that a firm facing such market evolution is always unsure about whether the current cycle is the last one, although it can update its beliefs about the probability of facing a permanent decline by observing that no further growth phase arrives. We show that the existence of regime shifts in fluctuating markets suffices for an option value of waiting to (dis)invest to arise, and we provide a marginal interpretation of the optimal (dis)investment policies, absent in the real options literature. The paper also shows that, despite the stochastic process of the underlying variable has a continuous sample path, the discreteness in the regime changes implies that the sample path of the firm's value experiences jumps whenever the regime switches all of a sudden, irrespective of whether the firm is active or not.
Keywords: Real Options, Regime-Switching, Bad News Principle, Signal Extraction Problem, Entry and Exit, Industry Life Cycles.
JEL Classification: D92, G31, L12
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
The Financing of Innovation: Learning and Stopping
By Dirk Bergemann and Ulrich Hege
-
Gradualism and Irreversibility
By Ben Lockwood and Jonathan Thomas
-
Strategic Experimentation with Exponential Bandits
By Martin Cripps, Godfrey Keller, ...
-
Strategic Experimentation with Exponential Bandits
By Martin Cripps, Godfrey Keller, ...
-
Strategic Experimentation with Poisson Bandits
By Godfrey Keller and Sven Rady
-
Strategic Experimentation with Poisson Bandits
By Godfrey Keller and Sven Rady
-
By Dirk Bergemann and Juuso Valimaki
-
Price Dispersion and Learning in a Dynamic Differentiated-Goods Duopoly
By Godfrey Keller and Sven Rady
-
On the Smoothness of Value Functions and the Existence of Optimal Strategies