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 publiéExternal document link
https://hal.archives-ouvertes.fr/ccsd-00997994/Date
2015-02Journal name
Journal of Economic Dynamics and ControlVolume
51Publisher
Elsevier
Pages
240–256
Publication identifier
Metadata
Show full item recordAuthor(s)
Aïd, RenéFederico, Salvatore
Université de Milan
Pham, Huyên
Université Paris Diderot, Sorbonne Paris Cité, Paris, France
Villeneuve, Bertrand

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 ratesSubjects / Keywords
Optimal capacity; Irreversible investments; Singular stochastic control; Time-to-build; Delay equationsRelated items
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