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Explicit investment rules with time-to-build and uncertainty

Aïd, René; Federico, Salvatore; Pham, Huyên; Villeneuve, Bertrand (2015), Explicit investment rules with time-to-build and uncertainty, Journal of Economic Dynamics and Control, 51, p. 240–256. http://dx.doi.org/10.1016/j.jedc.2014.10.010

Type
Article accepté pour publication ou publié
External document link
https://hal.archives-ouvertes.fr/ccsd-00997994/
Date
2015-02
Journal name
Journal of Economic Dynamics and Control
Volume
51
Publisher
Elsevier
Pages
240–256
Publication identifier
http://dx.doi.org/10.1016/j.jedc.2014.10.010
Metadata
Show full item record
Author(s)
Aïd, René

Federico, Salvatore
Université de Milan
Pham, Huyên
Université Paris Diderot, Sorbonne Paris Cité, Paris, France
Villeneuve, Bertrand cc
Abstract (EN)
We establish explicit socially optimal rules for an irreversible investment decision with time-to-build and uncertainty. Assuming a price sensitive demand function with a random intercept, we provide comparative statics and economic interpretations for three models of demand (arithmetic Brownian, geometric Brownian, and the Cox–Ingersoll–Ross). Committed capacity, that is, the installed capacity plus the investment in the pipeline, must never drop below the best predictor of future demand, minus two biases. The discounting bias takes into account the fact that investment is paid upfront for future use; the precautionary bias multiplies a type of risk aversion index by the local volatility. Relying on the analytical forms, we discuss in detail the economic effects. For example, the impact of volatility on the optimal investment is negligible in some cases. It vanishes in the CIR model for long delays, and in the GBM model for high discount rates
Subjects / Keywords
Optimal capacity; Irreversible investments; Singular stochastic control; Time-to-build; Delay equations
JEL
C61 - Optimization Techniques; Programming Models; Dynamic Analysis
D92 - Intertemporal Firm Choice, Investment, Capacity, and Financing
E22 - Investment; Capital; Intangible Capital; Capacity

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