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Irreversible investment with regime shifts |
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| Authors: | Xin Guo |
| Institution: | a Department of Operations Research and Industrial Engineering, Cornell University, 214 Rhodes Hall, Ithaca, NY 14853, USA b Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02215, USA c Ecole des HEC, University of Lausanne, Lausanne CH 1007, Switzerland d International Center FAME, 40bd. du Pont d'Arve, Geneva CH 1211, Switzerland e William E. Simon Graduate School of Business Administration, University of Rochester, Rochester NY 14627, USA |
| 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 possibility of a regime shift. Under this policy, investment is intermittent and increases with marginal q. Moreover, investment typically is very small but, in some states, the capital stock jumps. Implications for marginal q and the user cost of capital are also examined. |
| Keywords: | D92 E22 E32 |
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