production externalities and investment caps a welfare analysis under uncertainty abstract in markets where production has adverse externalities policy makers may wish to increase welfare by imposing a cap on the aggregate industry output in this paper we examine the implications that the cap has on the firms investment equilibrium policy and on social welfare in the presence of market uncertainty in contrast with previous literature we explicitly model the present externality and then let the social planner choose the cap level maximizing welfare we find that i if the consideration of market uncertainty triggers investment at price above the social marginal cost of production then it is optimal to have no cap at all ii otherwise the cap should be set at the current aggregate industry output and a ban on further market entries should be announced

energy conservation expectations and uncertainty this paper investigates consumers decisions about a single and lumpy conservation project accounting for uncertainty and expectations rational versus myopic rational expectations take into account that the profitability of individual conservation measures will affect fuel prices here set by cartelized supply ignorance of this interdependence between conservation and price leads to premature investments the interplay between demand and supply creates an incentive for a consumer cartel to initiate conservation strategically which advances conservation compared with rational consumers but not always ahead of individually myopic decisions

the economics of exchange rate regimes a review essay the exchange rate regime issue has taken centre stage in discussions of international economic policy much of the profession appears to have been converted to the hypothesis of the vanishing middle regime for countries well integrated into world capital markets there is little if any middle ground between floating exchange rates and monetary unification this paper considers the exchange rate regime issue in the context of recent books on the subject by w max corden and morris goldstein both authors prescribe managed floating exchange rates supplemented with inflation targeting for emerging market economies under managed floating and with a credible monetary policy the public finances in order and strengthened debt management and prudential regulation the exchange rate is free to act as a market gauge for assessing policies and as a mode of conflict resolution both authors also argue however that no exchange rate regime is a holy grail ultimately a credible exchange rate regime depends upon the trust evoked by governments there is no exchange rate regime whether of the managed floating or hard fix variety that can eradicate a history of failed stabilisation attempts

what to target inflation or exchange rate author affiliation shu lin shulin75 gmail comhaichun ye haichunye gmail com acknowledgment the authors would like to thank kent kimbrough and two anonymous referees for valuable comments 1 introductionone of the most important recent innovations in the conduct of monetary policy is inflation targeting in which a monetary authority makes public an estimated inflation rate or range and attempts to steer the actual inflation toward the target using monetary tools since its emergence in the early 1990s inflation targeting has certainly been gaining popularity over the last two decades by the end of 2006 27 countries among which 17 are developing countries had explicitly adopted this new monetary policy regime the emergence of inflation targeting has attracted substantial attention from both researchers and policymakers numerous studies have empirically evaluated the effects of adopting an explicit inflation targeting regime on a country s economic performance especially on inflation and growth while studies focusing on advanced industrial countries so far have yielded mixed results the evidence in developing countries seems to be more robust 1 batini kuttner and laxton 2005 goncalves and salles 2008 and lin and ye 2009 all find that inflation targeting significantly lowers inflation in developing countries where the credibility of the central bank has not yet been well established thus the credibility gain of adopting an explicit inflation targeting regime is substantial in addition capistran and ramos francia 2010 show that inflation targeting significantly lowers the dispersion of inflation expectations in developing countries two recent survey articles walsh 2009 and ball 2010 also concluded that inflation targeting has larger beneficial effects in developing countries than those in advanced industrial countries despite the success of inflation targeting in developing countries the more traditional exchange rate targeting framework still remains the dominant monetary policy regime in developing countries it is so popular that an influential study by calvo and reinhart 2002 finds an epidemic case of fear of floating in the developing world 2 furthermore similar to inflation targeting an exchange rate targeting regime especially a credibly enforced one is also viewed as an effective means to achieve price stability in developing countries because it serves as a nominal anchor by allowing a developing central bank to borrow credibility from a foreign monetary authority in a strict exchange rate targeting framework the targeting country s inflation rate should be equal to that of the country usually a low inflation rich country to which its exchange rate is pegged does an inflation targeting framework outperform an exchange rate targeting regime in achieving price stability in developing countries if so does this benefit come at a cost of slower growth these two important and policy related questions have not yet been examined in the literature a common feature of previous studies is that they all compare an inflation targeting regime with a very broad alternative namely a non inflation targeting regime while ignoring the substantial heterogeneity in the monetary policy regimes adopted by non inflation targeting countries a disadvantage of comparing inflation targeting with such a broad alternative is that the results may not be of direct use for policy choices the objective of this study therefore is to make the first attempt in the literature to conduct a direct empirical comparison of the emerging inflation targeting framework with the popular exchange rate targeting regime in developing countries in particular we compare the effects of these two monetary policy regimes on two key outcome variables inflation and economic growth our study is built upon three recent empirical works on the effects of inflation targeting in developing countries including batini kuttner and laxton 2005 goncalves and salles 2008 and lin and ye 2009 but we focus on directly comparing inflation targeting with exchange rate targeting

state dependent pricing and the dynamics of money and output standard macroeconomic models of price stickiness assume that each firm leaves its price unchanged for a fixed amount of time we present an alternative model in which the pricing decision depends on the state of the economy we find a method of aggregating individual price changes that allows a simple characterization of macroeconomic variables the model produces a positive money output correlation and an empirical phillips curve in addition the impact of monetary shocks depends crucially on the current level of output which points to a natural connection between state dependent microeconomics and state dependent macroeconomics i introduction there is a long tradition in macroeconomics of attributing the real effects of nominal demand shocks to nominal price stickiness in this view if there is no change in prices when nominal demand rises then quantities must bear the burden of adjustment hence nominal price rigidity provides the friction needed for nominal demand shocks to be transmitted to the real economy standard models of this transmission mechanism such as fischer 1977 and taylor 1980 are based on the assumption that each firm leaves its price unchanged for a fixed amount of time the main reason for considering such time dependent pricing rules is their analytic tractability constraining firms to adjust their prices at prespecified times both simplifies the derivation of equilibrium strategies and allows the use of powerful time series techniques to analyze aggregate dynamics the main disadvantage of the timedependent approach is that between price adjustments firms are not allowed to respond even to extreme changes of circumstance this makes it difficult to know whether the qualitative effects of money in these models are the result of nominal rigidities per se or of the exogenously imposed pattern of price changes an alternative approach to modeling price stickiness is to allow the price setting decision to depend on the actual state of the

on the option to invest in pollution control under a regime of tradable emissions allowances optimal decisions of a firm facing the option of retrofitting its plant to reduce pollution and thereby eliminate the need to purchase emissions allowances are analysed the decision is treated as a real option with the price of pollution permits following a known stochastic process the model is formulated as a set of one dimensional partial differential equations at discrete points in time the firm owner makes optimal decisions about the retrofit including whether to mothball temporarily the model is used to analyse a firm s decision to instal a scrubber as a result of the 1990 u s clean air act jel classification q25 d81 g31 sur la possibilite d investir dans le controle de la pollution dans un regime de permis d emission de pollution echangeables commercialement ce memoire examine les decisions optimales d une entreprise face a la possibilite d adapter ses installations pour reduire la pollution et ce faisant d eliminer le besoin de se procurer des permis d emission de pollution sur le marche le decision est traitee comme une option reelle ou le prix des permis resulte d un processus stochastique connu le modele est formule sous forme d un ensemble d equations differentielles partielles a une dimension a des points discontinus dans le temps le proprietaire de l entreprise prend des decisions optimales de mise a niveau des installations y compris la possibilite de les fermer temporairement le modele est utilise pour analyser une decision d installer un epurateur suite a la mise en place de la loi americaine de 1990 clean air act

capital controls capital flow contractions and macroeconomic vulnerability abstract in this paper i analyze whether restrictions to capital mobility reduce vulnerability to external shocks more specifically i ask if countries that restrict the free flow of international capital have a lower probability of experiencing a large contraction in net capital flows i use three new indexes on the degree of international financial integration and a large multi country data set for 1970 2004 to estimate a series of random effect probit equations i find that the marginal effect of higher capital mobility on the probability of a capital flow contraction is positive and statistically significant but very small having a flexible exchange rate greatly reduces the probability of experiencing a capital flow contraction the benefits of flexible rates increase as the degree of capital mobility increases a higher current account deficit increases the probability of a capital flow contraction while a higher ratio of fdi to gdp reduces that probability

debt in industry equilibrium this article shows 1 how entry and exit of firms in a competitive industry affect the valuation of securities and optimal capital structure and 2 how given a trade off between tax advantages and agency costs a firm will optimally adjust its leverage level after it is set up we derive simple pricing expressions for corporate debt in which the price elasticity of demand for industry output plays a crucial role when a firm optimally adjusts its leverage over time we show that total firm value comprises the value of discounted cash flows assuming fixed capital structure plus a continuum of options for marginal increases in debt article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

real investment decisions under adjustment costs and asymmetric information abstract we study the cost of adjustment model of investment when there is asymmetry of information between owners the principal and managers the agent information asymmetry distorts the relationship between investment and the cost of capital for all agent types and a regime of inaction appears over a certain cost range in an observationally different way than when fixed adjustment costs or irreversibilities cause a similar phenomenon uncertainty in the form of an increase in the spread of agents types tends to reduce investment despite symmetric adjustment cost and perfect competition the model gives a new interpretation of tobin s q under asymmetric information explaining some results of the mergers and acquisition literature

evaluating natural resource investments notwithstanding impressive advances in the theory of finance over the past 2 decades practical procedures for capital budgeting have evolved only slowly the standard technique which has remained unchanged in essentials since it was originally proposed see dean 1951 bierman and smidt 1960 derives from a simple adaptation of the fisher 1907 model of valuation under certainty under this technique expected cash flows from an investment project are discounted at a rate deemed appropriate to their risk and the resulting present value is compared with the cost of the project this standard textbook technique reflects modern theoretical developments only insofar as estimates of the discount rate may be obtained from crude application of single period asset pricing theory but see brennan 1973 bogue and roll 1974 turnbull 1977 constantinides 1978 the inadequacy of this approach to capital budgeting is widely acknowledged although not widely discussed its obvious deficiency is its the evaluation of mining and other natural resource projects is made particularly difficult by the high degree of uncertainty attaching to output prices it is shown that the techniques of continuous time arbitrage and stochastic control theory may be used not only to value such projects but also to determine the optimal policies for developing managing and abandoning them the approach may be adapted to a wide variety of contexts outside the natural resource sector where uncertainty about future project revenues is a paramount concern

global warming irreversibility and learning a number of economists have argued that the literature on the irreversibility effect implies that current abatement of greenhouse gas emissions should be greater when there is the possibility of obtaining better information in the future about the potential damages from global warming than when there is no possibility of obtaining better information in this paper we show that even the simplest model of global warming does not satisfy either of epstein s 1980 sufficient conditions so it is not possible to use epstein s analysis to tell whether the irreversibility effect applies to models of global warming we derive an alternative sufficient condition for the irreversibility effect to hold

investment under uncertainty with price ceilings in oligopolies abstract we study the impact of price cap regulation on the level and timing of investment in an oligopolistic cournot industry facing stochastic demand we find that a price ceiling affects investment decisions in two mutually competing ways it makes the option to defer investment more valuable but at the same time it reduces the incentive for firms to strategically underinvest in order to raise prices we show that while sensible price cap regulation speeds up investment a low price cap can be a disincentive for investment there exists an optimal price cap independent of market concentration the competitive investment price trigger that maximizes investment incentives and in the long term increases industry installed capacity this optimal price cap becomes less effective and less robust as the market becomes more competitive and as demand volatility increases errors in estimation of the optimal price cap have asymmetric effects underestimation has more dire consequences than overestimation

technology choice under several uncertainty sources abstract we analyze a model of irreversible investment with two sources of uncertainty a risk neutral decision maker has the choice between two mutually exclusive projects under input price and output price uncertainty we propose a complete study of the shape of the rational investment region and we prove that it is never optimal to invest when the alternative investments generate the same payoff independently of its size a key feature of this bidimensional degree of uncertainty is thus that the payoff generated by each project is not a sufficient statistic to make a rational investment in this context our analysis provides a new motive for waiting to invest the benefits associated with the dominance of one project over the other as an illustration we apply our methodology to power generation under uncertainty

investment and competition this paper examines how industry structure affects corporate investment patterns real options theory shows that deferring irreversible investment in the face of uncertainty is valuable theory also shows that the value of waiting to invest falls if investment opportunities are contestable consistent with these theories we find that firms in monopolistic industries exhibit lower investment q sensitivity and are slower to invest than firms in competitive industries however we find that investment q sensitivity and investment speed are highest in oligopolistic industries suggesting that the value of investing strategically can outweigh the value of waiting indeed oligopolistic industries experience less entry and more exit than other industries

investment under uncertainty and time inconsistent preferences abstract while standard real options models assume that agents possess a constant rate of time preference there is substantial evidence that agents are impatient about choices in the short term but are patient when choosing between long term alternatives we extend the real options framework to model the investment timing decisions of entrepreneurs with time inconsistent preferences the impact on investment timing depends on such factors as whether entrepreneurs are sophisticated or naive in their expectations regarding their future time inconsistent behavior and whether the payoff from investment occurs all at once or over time the model is extended to the case of a competitive equilibrium

financial globalisation and crisis institutional transformation and equity this paper comprises the long introduction to the symposium of five papers on financial globalisation published in the cambridge journal of economics volume 34 no 2 the paper discusses the impact of financial globalisation in a variety of spheres and shows how the five papers link together to provide a coherent view of the current economic and financial crisis in this paper we also examine the globalisation of finance more broadly both in historical terms as well as in relation to the current widespread failure in the financial markets we take up the policy question of how the interests of the poor in particular and developing countries in general could be safeguarded from the vagaries of financial globalisation questioning how much choice communities and countries have and what can the international community do to extend these choices

strategic investment under uncertainty a synthesis abstract investment is a central theme in economics finance and operational research traditionally the focus of analysis has been either on assessing the value of flexibility investment under uncertainty or on describing commitment effects in competitive settings industrial organization research contributions addressing the intersection of investment under uncertainty and industrial organization have become numerous in recent years in this paper we provide an overview aimed at categorizing and relating these research streams we highlight managerial insights concerning the nature of competitive advantage first versus second mover advantage the manner in which information is revealed firm heterogeneity capital increment size and the number of competing firms

unique equilibrium in a model of self fulfilling currency attacks even though self fulfilling currency attacks lead to multiple equilibria when fundamentals are common knowledge we demonstrate the uniqueness of equilibrium when speculators face a small amount of noise in their signals about the fundamentals this unique equilibrium depends not only on the fundamentals but also on financial variables such as the quantity of hot money in circulation and the costs of speculative trading in contrast to multiple equilibrium models our model allows analysis of policy proposals directed at curtailing currency attacks

an equilibrium model of investment under uncertainty this paper analyzes the optimal investment decisions of heterogeneous rms in a competitive uncertain environment we characterize rms optimal investment strategy explicitly and derive a closed form solution for rm value we show that in the strategic equilibrium real option premia are signi cant as a result rms delay investment choosing optimally not to undertake some positive npv projects the model predicts that rm returns vary over the business cycle with returns negatively skewed during expansions but positively skewed in recessions

international financial crises causes prevention and cures dale jorgenson has bestowed a great honor and no small challenge by inviting me to give this lecture a great honor because of the distinguished list of economists who have preceded me a challenge because of the standard they have set and because there is no greater challenge for any economist than providing a coherent account of significant events to his scientific peers i am sometimes asked by friends about the differences between academic life and life as a public official there are many two stand out first as an academic the gravest sin one can commit is to sign one s name to something one did not write as a public official it is a mark of effectiveness to do so as often as possible second as an academic if a problem is too hard and does not admit of a satisfactory solution there is an obvious response work on a different problem that is not a luxury that one has in government i have been reminded of this often in recent years as we have grappled with financial crises in a number of what had previously been considered emerging markets with unrestrained futures anyone who doubts the social importance of what economists do should consider the debates surrounding these crises hundreds of millions of people who expected rapidly rising standards of living have seen their living standards fall hundreds of thousands if not millions of children have been forced to drop out of school and go to work hundreds of billions of dollars of apparent wealth has been lost the stability of large nations as nations has been called into question and the united states has made its largest nonmilitary foreign policyrelated financial commitments since the marshall plan almost all the issues involved in understanding preventing and mitigating these crises are the stuff of economics courses and research fixed versus flexible exchange rates moral hazard and multiple equilibria speculation and liquidity fiscal and monetary policies regulation and competition what economists think say and do has profound implications for the lives of literally billions of their fellow citizens whether it is discussing the role of derivatives in signaling exchange rate commitments with chinese premier zhu rongji or discussing an nber working paper on inflation targeting with the brazilian central bank governor arminio fraga or discussing alternative approaches to bankruptcy law with indonesia s economic team or optimal debt durations with the mexican authorities i am consistently struck by the impact of the kind of research discussed at the aea meetings the future well being of the world s people in large part will depend on how the ongoing process of global integration works out this is a strong statement but one that is supported by the global economy s post world war i failure and its post world war ii success central to global integration is financial integration the flow of funds and of capital across international borders and as the events of the late 1920 s and early 1930 s remind us central to global disintegration can be international financial breakdowns today i want to reflect on the issue of global financial integration in light of the dramatic and largely unpredicted events of recent years it is perhaps a good time for reflection there has been enough repair that priority can shift from u s department of the treasury 1500 pennsylvania avenue washington dc 20005 this lecture reflects many things i have learned from experiences i have shared with colleagues in the united states government and governments around the world i thank brad delong marty feldstein stephanie flanders ken rogoff andrei shleifer and ted truman for useful comments and suggestions i am especially grateful to nouriel roubini and stephanie flanders for valuable discussions and assistance in the preparation of this lecture the usual disclaimer applies

market concentration macroeconomic uncertainty and monetary policy abstract this paper studies the effect of market structure and macroeconomic uncertainty on the transmission of monetary policy we motivate our analysis with a simple model which predicts that 1 investment and production in more concentrated sectors are more affected by demand shocks and 2 high uncertainty makes investment and production more sensitive to demand shocks the empirical analysis estimates the effect of monetary shocks on sectoral output for different sectors in the us using a structural vector autoregressive var approach the results are generally consistent with the theoretical predictions

a dynamic duopoly investment game without commitment under uncertain market expansion abstract we model capacity building investments in a homogeneous product duopoly facing uncertain demand growth capacity building is achieved through the addition of production units that are durable and lumpy and whose cost is irreversible while building their capacity over time firms compete a la cournot in the product market given their installed capacity there is no exogenous order of moves no commitment regarding future decisions and no finite horizon we investigate markov perfect equilibrium mpe paths of the investment game which may include episodes during which firms invest at different times a preemption pattern and episodes in which firms invest simultaneously a tacit collusion pattern these episodes may alternate and are typically several when firms have yet to invest in capacity the sole pattern that is mpe compatible is a preemption episode firms invest at different times but have equal value the first such investment may occur earlier and therefore be riskier than socially optimal when both firms hold capacity tacit collusion episodes may be mpe compatible firms invest simultaneously at a postponed time hence holding back production in the meantime thereby generating an investment wave in the industry such investment episodes are more likely with higher demand volatility faster market growth and lower cost of capital discount rate

the mirage of fixed exchange rates this paper discusses the profound difficulties of maintaining fixed exchange rates in a world of expanding global capital markets contrary to popular wisdom industrialized country monetary authorities easily have the resources to defend exchange parities against virtually any private speculative attack but if their commitment to use those resources lacks credibility with markets the costs to the broader economy of defending an exchange rate peg can be very high the dynamic interplay between credibility and commitment is illustrated by the 1992 swedish and british crises and the 1994 95 mexican collapse we also discuss the small number of successful fixers

prices vs quantities the irrelevance of irreversibility we explore the efficacy of price and quantity controls in a dynamic setup in which the decisions of some agents are irreversible the assumption of irreversibility is shown to improve the performance of a tax relative to that of a system of tradable quotas and significantly alter the equilibrium behavior of agents we nevertheless conclude that taking into account the fact that agents decisions may be irreversible does not lead to policy implications significantly different from those reached in a simpler model in which irreversibility is ignored

a new paradigm for valuing non market goods using referendum data maximum likelihood estimation by censored logistic regression abstract this paper challenges the w m hanemann amer j agr econom 66 332 341 1984 and c sellar j p chavas and j r stoll j environ econom management 13 382 390 1986 utilizations of logit models to estimate the value of non market resources from referendum survey data these data are more informative than conventional choice data the random utility interpretation of logit models is therefore too restrictive bypassing the utility function entirely it will be shown that parameters and standard errors for utility theoretic inverse hicksian demand functions can be extracted directly and much more simply estimated demand functions need not be limited to those corresponding to the linear in parameters utility difference specifications which can be handled by packaged logit programs

the externalities associated with the common property exploitation of groundwater abstract in this paper the rate of groundwater extraction under the common property arrangement is the outcome of a dynamic game played with feedback strategies the analysis clarifies the externalities associated with the common property extraction of groundwater and identifies an risk externality that arises when firms are risk averse identifying the various externalities bears on the development of appropriate forms of groundwater management in particular the risk externality would be unknown to the watermaster of a central control agency suggesting the need for creative decentralized forms of groundwater management

irreversible abatement investment under cost uncertainties tradable emission permits and emissions charges abstract a major concern with tradable emission permits is that stochastic permit prices may reduce a firm s incentive to invest in abatement capital or technologies relative to other policies such as a fixed emissions charge however under efficient permit trading the permit price uncertainty is caused by abatement cost uncertainties which affect investment under both permit and charge policies we develop a rational expectations general equilibrium model of permit trading and irreversible abatement investment to show how cost uncertainties affect investment under permits we compare the resulting investment incentive with that under charges after controlling for the assumption that random shocks affect the abatement cost linearly we find that firms investment incentive decreases in cost uncertainties but more so under emissions charges than under permits therefore tradable permits in fact may help maintain firms investment incentive under uncertainty

the effect of mean reversion on investment under uncertainty abstract mean reverting processes are appropriate for most real option investment models yet geometric brownian motion gbm processes are generally used for tractability hassett and metcalf j econom dyn control 19 1995 1471 1488 argue that using a gbm process is justified because mean reversion has two opposing effects it brings the investment trigger closer and also reduces the conditional volatility thereby lowering the likelihood of reaching the trigger and the overall effect on investment should be negligible for most reasonable parameter values this paper extends the hassett and metcalf model by incorporating a third factor the effect of mean reversion on systematic risk the main result is that mean reversion in general does have a significant impact on investment moreover this effect could be either positive or negative depending on various factors such as project duration cost of investing interest rate etc thus it is generally inappropriate to use the gbm process to approximate a mean reverting process

shareholders and stakeholders human capital and industry equilibrium producing high technology output and supplying sophisticated services often involves costly investment in industry specific skills but the threat of poaching means that it is the individual stakeholder not the firm who must bear the cost we investigate various mechanisms for funding human capital investment in an industry equilibrium framework where capital market imperfections would in the absence of intervention result in underinvestment the main result is that government provision of loan guarantees conditional on no bankruptcy leads to wage hikes which raises profits in a socially inefficient manner income contingent loans and levy subsidy schemes meanwhile can result in a socially efficient outcome recent analysis of investment under uncertainty has stressed the irreversible commitment that this may involve and the value of waiting before committing or withdrawing resources dixit and pindyck 1994 the investment considered is usually in physical capital oil rigs for example and the decision makers are the shareholders who own equity capital or their delegates but in many high technology and service industries investments of a less tangible nature are also required those in human skills if they are costly to acquire and are not transferable outside the industry then this will also involve irreversible decisions under uncertainty

investment under alternative return assumptions comparing random walks and mean reversion abstract many recent theoretical papers have come under attack for modeling prices as geometric brownian motion this process can diverge over time implying that firms facing this price process can earn infinite profits we explore the significance of this attack and contrast investment under geometric brownian motion with investment assuming mean reversion while analytically more complex mean reversion in many cases is a more plausible assumption allowing for supply responses to increasing prices we show that cumulative investment is generally unaffected by the use of a mean reversion process rather than geometric brownian motion and provide an explanation for this result

learning and stock effects in environmental regulation the case of greenhouse gas emissions abstract this paper concerns the optimal regulation of greenhouse gases that lead to global climate change in particular we focus on uncertainty and learning which over time resolves uncertainty we present an empirical stochastic model of climate economy interactions and present results on the tension between postponing control until more is known vs acting now before irreversible climate change takes place uncertainty in our model is in the damage caused by global warming the results suggest that a temporary carbon tax may dominate a permanent one because a temporary tax may induce increased flexibility

irreversible investment and strategic interaction this paper introduces an aggregate demand externality into a model of irreversible invest ment the central result of the paper establishes the mechanism in which increases in uncer tainty can lead to suboptimal recessions these inefficient outcomes occur even if agents are allowed to coordinate to the best possible equilibria the result is driven by the external effects of firms investment decisions how can a small increase in uncertainty cause a large suboptimal drop in output this paper studies this question through a simple model of investment coupled with aggregate demand externalities the idea that economic uncer tainty is high in times preceding and during recessions is very intuitive how ever a study of its causal role for suboptimal business cycles is hampered by the absence of any rigorous transmission mechanism we are proposing one such mechanism and while our model is too stylized to allow for any direct empirical test we hope that it is the first step towards the creation of robust models with testable implications our analysis takes place in an uncertain environment where firms must choose a level of irreversible investment the literature on this problem is well developed with the fairly robust result that either an increase in uncertainty or an increase in the quality of information to arrive in the future will cause

bank run psychology abstract banks are inherently susceptible to panics and bank runs due to the problem of maturity mismatch resulting in both a stable equilibrium in which the bank survives and an unstable equilibrium in which a bank run occurs understanding equilibrium selection in this setting is extremely important for safeguarding financial stability in this paper one new potential factor that determines whether a bank runs gets triggered or not is experimentally studied namely the psychological state of the depositor prior to participating in an experimental bank run game subjects are either induced with fear sadness or happiness using an autobiographical emotion induction task the findings suggest that the presence of background fear significantly increases the likelihood of withdrawal and a subsequent bank run in addition women are shown to be significantly more likely to withdraw then men but only in the fear induction treatment

timing of investments in oligopoly under uncertainty a framework for numerical analysis abstract we present a modeling framework for the analysis of investments in an oligopoly market for a homogenous commodity the demand evolves stochastically and the firms carry out investment projects in order to adjust their production cost functions or production capacities the model is formulated as a discrete time state space game where the firms use feedback strategies the firms are assumed to move sequentially to ensure a unique markov perfect nash equilibrium once the equilibrium has been solved monte carlo simulation is used to form probability distributions for the firms cash flow patterns and accomplished investments such information can be used to value firms operating in an oligopoly market an example of the model is given in a duopoly market the example illustrates the trade off between the value of flexibility and economies of scale under competitive interaction

inducing investments and regulating externalities by command versus taxes a linear tax on an externality generating activity may not attain the first best social optimum the problem arises because a monopolist s gain from improving the characteristics of a product may differ from the social gain even when consumers are willing to pay for the change

administrative creation of property rights to radio spectrum abstract despite the 1934 communication act s ban on private ownership of radio spectrum the law leaves open to the federal communications commission a range of licensing regimes under which the commission may in its discretion grant spectrum users relatively strong or weak property rights to allotted frequencies this article examines numerous administrative decisions by the fcc to demonstrate how regulatory changes have affected the property interests conferred by spectrum licenses focusing on licensees rights to use divide and broker spectrum flexibly and to prevent unauthorized reception of their signals the article discusses the economic and legal significance of those changes and identifies areas for further reform the authors conclude that although important changes remain to be made the fcc has strengthened property interests on both the transmission and receiving ends of licensed frequencies and through the administrative process has eroded the importance of the statutory distinction

irreversible investment under uncertainty in oligopoly abstract an oligopoly is studied where firms facing a stochastic inverse demand curve use capacity as strategic variable capacity may be adjusted continuously over time with linear cost the analysis uses the technique of a fictitious social planner and the theory of irreversible investment under uncertainty examples indicate that qualitatively the price process will be similar in oligopoly and competitive equilibrium when firms are nonidentical e g in initial size and even if they are alike in other respects substantial time may pass until they are all the same size much of that time one firm may dominate the market

currency crashes in emerging markets an empirical treatment we use a panel of annual data for over 100 developing countries from 1971 through 1992 to characterize currency crashes we define a currency crash as a large change of the nominal exchange rate that is also a substantial increase in the rate of change of nominal depreciation we examine the composition of the debt as well as its level and a variety of other macroeconomic factors external and foreign crashes tend to occur when output growth is low the growth of domestic credit is high and the level of foreign interest rates are high a low ratio of fdi to debt is consistently associated with a high likelihood of a crash

environment asset characteristics and optimal effluent fees this article investigates theissue of optimal effluent fees in a frameworkwhere waste emissions are abated by investingin capital of which the pay off is uncertainand the cost is fully sunk the stock of wasteemissions harms an individual firm sproduction but the firm will underestimatethis external effect upon investing consequently the firm will invest lesscapital and thereby pollute more than issocially desirable the regulator who can useeffluent fees to correct this should imposelower effluent fees on irreversible investmentsthan on costlessly reversible ones whenuncertainty arises

optimal pricing of environmental and natural resource use with stock externalities abstract underlying some of the most pressing environmental problems are the interlinked resource and environmental stock externalities with threshold effects using a simple dynamic model it is shown how in the face of such externalities the static market based policy instruments such as pigouvian taxes should be modified it is shown that even if for an initial period there is going to be no pollution stock damage the optimal policy still requires that abatement begins immediately and at increasing rates simulation of the model for the case of fossil fuel burning and the consequent global warming shows that the optimal carbon tax and therefore the optimal control strategy is particularly sensitive to changes in the marginal abatement cost and the level of fossil fuel demand policy simulations contrast the optimal control policy with and estimate the welfare losses from alternative policies deriving from arbitrary tax paths the latter include i a no tax policy ii a constant carbon tax rate iii the european community s proposed carbon tax path and iv a delayed optimal tax path

a real options analysis of coffee planting in vietnam vietnam grew from an insignificant to the world s second largest coffee producer during the 1990s to understand this growth this article examines vietnamese coffee growers investment decisions using real options theory the study finds that producers with variable costs of 19 cents lb and total cost of 29 3 cents lb would enter coffee production at a coffee price of 47 cents lb and exit at a coffee price of 14 cents lb most vietnamese growers appear to be sufficiently efficient to continue producing coffee even at relatively depressed price levels

the impact of debt financing on entry and exit in a duopoly this article investigates the interaction between market entry company foreclosure and capital structure in a duopoly we find that the order in which firms foreclose is determined not only by differences in firm specific factors but also by common economic factors such as the interest rate and the market profit volatility we extend the exit model by allowing financially distressed firms to renegotiate their debt contracts through a one off debt exchange offer we find that firms with high bankruptcy costs or with prospects of profit improvement can get bigger reductions on their debt repayments investigating market entry we find that financial vulnerability of the incumbent induces earlier entry article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

option exercise games an application to the equilibrium investment strategies of firms under the standard real options approach to investment under uncertainty agents formulate optimal exercise strategies in isolation and ignore competitive interactions however in many real world asset markets exercise strategies cannot be determined separately but must be formed as part of a strategic equilibrium this article provides a tractable approach for deriving equilibrium investment strategies in a continuous time cournot nash framework the impact of competition on exercise strategies is dramatic for example while standard real options models emphasize that a valuable option to wait leads firms to invest only at large positive net present values the impact of competition drastically erodes the value of the option to wait and leads to investment at very near the zero net present value threshold copyright 2002 oxford university press

investment in competitive equilibrium the optimality of myopic behavior there is an extensive literature on the optimal irreversible investment strategy of a solitary firm facing an exogenous price process this paper shows that the investment strategies that this literature derives may be optimal in competitive equilibrium even though the price process is now endogenous this provides a simple means for computing equilibrium investment strategies

distribution free estimation with interval censored contingent valuation data troubles with turnbull contingent valuation cv surveys frequently employ elicitation procedures that return interval censored data on respondents willingness to pay wtp almost without exception cv practitioners have applied turnbull s self consistent algorithm to such data in order to obtain nonparametric maximum likelihood npml estimates of the wtp distribution this paper documents two failings of turnbull s algorithm 1 that it may not converge to npml estimates and 2 that it may be very slow to converge with regards to 1 we propose starting and stopping criteria for the algorithm that guarantee convergence to the npml estimates with regards to 2 we present a variety of alternative estimators and demonstrate through monte carlo simulations their performance advantages over turnbull s algorithm

a model of financial structure and financial fragility this paper presents an asymmetric information model of financial structure the model has two types of financial institutions banks and securities markets both of which can hold loans made to firms to finance investment projects the securities markets have lower costs but they have a lemons problem because the banks have better information the result is an equilibrium that can exhibit fragility in the sense that small parameter changes such as changes in the cost advantage of the securities market or the risk structure of loans can lead to discontinuous changes in interest rates asset prices and market structure

real options and preemption under incomplete information abstract this paper introduces incomplete information and preemption into an equilibrium model of firms facing real investment decisions the optimal investment strategy may lie anywhere between the zero npv trigger level and the optimal strategy of a monopolist depending on the distribution of competitors costs and the implied fear of preemption our model implies that the equity returns of firms which hold real options and are subject to preemption will contain jumps and positive skewness

distinguished lecture on economics in government exchange rate regimes is the bipolar view correct the choice of appropriate exchange rate regime which for economies with access to international capital markets increasingly means a move away from the middle ground of pegged but adjustable fixed exchange rates towards the two corner regimes of either flexible exchange rates or a fixed exchange rate supported if necessary by a commitment to give up altogether an independent monetary policy lawrence h summers 2000 p 8

crisis costs and debtor discipline the efficacy of public policy in sovereign debt crises abstract recent debate on the reform of the international financial architecture has highlighted the potentially important role of the official sector in crisis management we examine how such public intervention in sovereign debt crises affects efficiency ex ante and ex post our results shed light on the scale of capital inflows and the implications for debtor country output of such a regime the efficacy of measures such as officially sanctioned stays on creditor litigation depend critically on the quality of public sector surveillance and the size of the costs of sovereign debt crises

potential for tradable water allocation and rights in jordan this paper estimates the costs of buying water use rights from farmers located in the mafraq azraq basin in jordan the farmers water supply curve is estimated using data gathered from a contingent valuation survey and nonparametric procedures estimation results indicate that a total supply of 29 million m 3 could be periodically purchased from farmers at an annual price of approximately jd 0 23 m 3 1 jd 0 70 us or a total cost of about jd 6 8 million per year

exit in duopoly under uncertainty this paper examines a declining duopoly where the firms must choose when to exit from the market the uncertainty is modeled by letting the revenue stream follow a geometric brownian motion we consider the markovperfect equilibrium in firms exit strategies with a low degree of uncertainty there is a unique equilibrium where one of the fi rms always exits before the other however when uncertainty is increased another equilibrium with the reversed order of exit may appear ruining the uniqueness whether this happens or not depends on the degree of asymmetry in the firm specifi cp arameters

entry and exit decisions under uncertainty the limiting deterministic case abstract this paper establishes the general deterministic limit that corresponds to dixit s model of entry and exit decisions under uncertainty the interlinked nature of decisions is shown to be essential also in the deterministic limit a numerical example illustrates the result

production and spatial distribution of switchgrass and miscanthus in the united states under uncertainty and sunk cost abstract the u s cellulosic biofuel mandate has not been enforced in recent years uncertainty surrounding the enforcement of the mandate in addition to high production and harvest cost have contributed to a delay in the widespread planting of bioenergy crops such as switchgrass and miscanthus previous literature has shown that under uncertainty and sunk cost an investment threshold is further increased due to the value associated from holding the investment option in this paper we extend the previous literature by applying a real option switching model to bioenergy crop production first we calculate the county level break even price which triggers a switching away from traditional field crops corn soybeans and wheat to bioenergy crops under various scenarios differing by commodity prices production cost and biomass price expectations we show that the resulting break even prices at the county level can be substantially higher than previously estimated due to the inclusion of the option value in a second step we identify counties that are most likely to grow switchgrass or miscanthus by simulating a stochastic biomass price over time our results highlight two issues first switchgrass or miscanthus are not grown in the midwest under any scenario under low agricultural residue removal rates biomass crops are mostly grown in the southeast second under the assumption of a high removal rates bioenergy crops are not grown anywhere in the u s since the cellulosic biofuel mandate can be covered by agricultural residues

uncertainty and stepwise investment we analyze the optimal investment strategy of a firm that can complete a project either in one stage at a single freely chosen time point or in incremental steps at distinct time points the presence of economies of scale gives rise to the following trade off lumpy investment has a lower total cost but stepwise investment gives more flexibility by letting the firm choose the timing individually for each stage our main question is how uncertainty in market development affects this trade off the answer is unambiguous and in contrast with a conventional real options intuition higher uncertainty makes the single stage investment more attractive relative to the more flexible stepwise investment strategy

open loop equilibria and perfect competition in option exercise games the investment boundaries defined by grenadier 2002 for an oligopoly investment game determine equilibria in open loop strategies as closed loop strategies they are not equilibria because any firm by investing sooner can preempt the investments of other firms and expropriate the growth options the perfectly competitive outcome is produced by closed loop strategies that are mutually best responses in this equilibrium the option to delay investment has zero value and the simple npv rule is followed by all firms the author 2009 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please e mail journals permissions oxfordjournals org oxford university press

irreversible investment real options and competition evidence from real estate development abstract we examine the extent to which uncertainty delays investment and the effect of competition on this relationship using a sample of 1214 condominium developments in vancouver canada built from 1979 1998 we find that increases in both idiosyncratic and systematic risk lead developers to delay new real estate investments empirically a one standard deviation increase in the return volatility reduces the probability of investment by 13 percent equivalent to a 9 percent decline in real prices increases in the number of potential competitors located near a project negate the negative relationship between idiosyncratic risk and development these results support models in which competition erodes option values and provide clear evidence for the real options framework over alternatives such as simple risk aversion

efficient estimation methods for closed ended contingent valuation surveys closed ended contingent valuation surveys can be very useful in the evaluation of nonmarket resources respondents merely state whether they would accept or reject a hypothetical threshold amount either as payment for giving up access to the resource or as a fee for its use the authors develop a maximum likelihood procedure which exploits the variation in the threshold values to allow direct and separate point estimates of regression like slope coefficients and error standard deviations without truncation bias their illustration uses data from a survey of recreational fisherman to examine factors which influence individuals willingness to pay copyright 1987 by mit press

investment in oligopoly under uncertainty the accordion effect this paper studies investments in new markets where more than two anticipated identical competitors are present in case of three firms an accordion effect is detected an exogenous demand shock results in a change of the wedge between investment thresholds of the first and second investor that is qualitatively different from the change of the wedge between the second and third investment threshold furthermore it turns out that in the three firm case the investment timing of the first investor lies in between the one and the two firm case these results are numerically extended to the n firm case

does it pay to go to the corners an empirical evaluation of the bipolar view of exchange rate regimes abstract this paper provides the first empirical evidence for the controversial bipolar view which suggests that countries should move towards the two corner regimes my results show that compared to intermediate regimes the two corners are associated with significantly lower inflation

developing real option game models by mixing concepts from both game theoretic analysis and real options theory an investment decision in a competitive market can be seen as a game between firms as firms implicitly take into account other firms reactions to their own investment actions we review two decades of real option game models suggesting which critical problems have been solved by considering game theory and which significant problems have not been yet adequately addressed we provide some insights on the plausible empirical applications or shortfalls in applications to date and suggest some promising avenues for future research

investment under uncertainty does competition matter abstract empirical applications of real options models in competitive environments implicitly exploit the optimality of myopic planning in a seminal paper leahy j v 1993 investment in competitive equilibrium the optimality of myopic behavior quarterly journal of economics 108 1105 1133 shows that the optimal investment strategy of a myopic planner who ignores market entries and exits of competitors as well as the resulting price effects constitutes a market equilibrium under rather general conditions as a result the calculation of optimal investment strategies is simplified considerably because competition does not have to be taken into account in this paper however we demonstrate by using simulation experiments that myopic planning may lead to non optimal investment strategies this is due to the fact that it is difficult or even impossible to specify the correct or equivalent price process for the myopic investor using real world data we quantify the degree of suboptimality and propose measures to reduce the error

understanding investment irreversibility in general equilibrium miquel faig i introduction many forms of investment are irreversible a growing body of literature 1 has shown that irreversibility is important for firms investment decisions under uncertainty however we still know little about the consequences of investment irreversibility for the economy as a whole that is in general equilibrium learning about these consequences is not only important for a better understanding of capital accumulation it is also important for an understanding of the information that asset returns provide about the business cycle in fact recent papers by boldrin christiano and fisher 1995 beaudry and guay 1996 and jermann 1998 convincingly argue that impediments to the reallocation of capital are crucial to generate realistic dynamics for asset returns thus understanding the general equilibrium consequences of investment irreversibility is important to the theories of economic growth the business cycle and asset pricing in this article i advance an analytically tractable model to explore the consequences of investment irreversibility in general equilibrium the main contribution of this model to the existing literature is analytical tractability analytical results from the literature dealing with investment irreversibility in general equilibrium are scarce and mainly limited to general properties such as existence of solutions as in sargent 1980 and olson 1989 fortunately thanks to numerical simulations we know some of the effects of investment irreversibility in general equilibrium for example using an extension to the neoclassical growth model coleman 1997 documents that irreversibility significantly affects interest rates and it may increase aggregate investment even when no constraints are binding 2 in contrast firms behavioral analyses and the related competitive equilibrium model by leahy 1993 show that irreversibility typically discourages capital creation the model advanced in this paper helps to understand and to formalize why such contrast exists the model of this article extends the endogenous growth model found in barro 1990 the four main assumptions of the model are the following all production processes yield the same output which can be consumed or invested in many types of capital all factors of production are a type of capital the aggregate production function yields constant returns to scale preferences are homothetic and modeled along the lines of epstein and zin 1989 these preferences include as a special case the standard isoelastic time additive preferences but they allow to distinguish between the inter temporal elasticity of substitution and the inverse of the coefficient of relative risk aversion these two parameters play important and distinct roles in the analysis to attain strong analytical results the model in this article has to adopt the restrictive assumption that all factors of production are a form of capital however the model remains quite flexible to capture important elements of reality the model allows for many types of capital so some of them can be interpreted as human capital also the model allows great flexibility on the stochastic shocks affecting the production possibilities of the economy finally the model allows for the coexistence of irreversible and flexible types of capital with or without complementarities between them this diversity of capital types is important to generate endogenous interest rates and endogenous marginal products of capital also capital diversity allows for strongly binding irreversibility constraints even with positive gross investment as it has always been the model reveals that in general equilibrium there are three effects of irreversibility on aggregate investment the first is the obvious direct effect of preventing capital destruction in periods one may wish to consume part of the capital stock

irreversible investment with price ceilings a model of irreversible investment in a competitive industry under demand uncertainty is developed in the absence of restrictions investment by itself will keep the price from rising above a natural ceiling that exceeds the long run average cost by an option value factor when a lower ceiling is imposed investment is triggered only by the observation of an even higher shadow price as the imposed ceiling is reduced to the long run average cost this shadow price goes to infinity and investment ceases completely because investment is depressed a tighter price ceiling generally leads to a higher long run average price

strategic capacity investment under uncertainty this article considers investment decisions within an uncertain dynamic and duopolistic framework each investment decision involves to determine the timing and the capacity level the simultaneous analysis of timing and capacity decisions extends work on entry deterrence accommodation to consider a timing delay element we find that when applying an entry deterrence policy the first investor or incumbent overinvests in capacity for two reasons first it delays the investment of the second investor or entrant second the entrant will invest in less capacity we also find that greater uncertainty makes entry deterrence more likely

preemption and rent dissipation under price competition abstract we study a simple duopoly model of preemption with multiple investments and instantaneous price competition on a market of finite size driven by stochastic taste shocks different patterns of equilibria may arise depending on the importance of the real option effect if the average growth rate of the market is close to the risk free rate or if the volatility of demand shocks is high no dissipation of rents occurs in equilibrium despite instantaneous price competition if these conditions do not hold the equilibrium investment timing is suboptimal and the firms long run capacities may depend on the initial market conditions our conclusions contrast sharply with standard rent dissipation results

irreversible investment with uncertainty and scale economies abstract optimal irreversible investment policy is analyzed when profits undergo multiplicative geometric brownian shocks the marginal product of capital increases initially and then decreases in the latter range it is optimal to add capacity gradually as the shock rises to a threshold where the expected return on the marginal unit is a multiple of its cost reflecting the option value of waiting the optimal policy in the increasing marginal product range obeys the same multiple now applied to the total return on an optimal discrete capacity addition implications for economic growth and suboptimal equilibria under external economies are examined

value based trading of real assets in shipping under stochastic freight rates the article uses a real options valuation model with stochastic freight rates to investigate market efficiency and the economics of switching between the dry bulk and the tanker markets in international shipping a dry bulk carrier is replaced with a tanker when the expected net present value of such a switch is optimal from a real options based decision rule depending on the development of the markets a reversal may take place later the cost and demand parameters upon which the decisions to switch are made including the stochastic characteristics of freight rates are estimated from an empirical analysis that is updated every week throughout a 12 year time period from 1993 to 2005 the second hand market for bulk ships seems to have been efficient most of these years in the sense that market switching usually did not pay off with one major exception it seemed profitable in expectation to leave the dry bulk market and enter the tanker market over a significant period of time shortly after the millenn

the modern history of exchange rate arrangements a reinterpretation we develop a novel system of reclassifying historical exchange rate regimes one key difference between our study and previous classifications is that we employ monthly data on market determined parallel exchange rates going back to 1946 for 153 countries our approach differs from the imf official classification which we show to be only a little better than random it also differs radically from all previous attempts at historical reclassification our classification points to a rethinking of economic performance under alternative exchange rate regimes indeed the breakup of bretton woods had less impact on exchange rate regimes than is popularly believed

pollution accumulation and firm incentives to accelerate technological change under uncertain private benefits the paper explores the relationships between the design of public incentives and the policy maker s desired timing of abandonment of a polluting technology when this requires an irreversible private investment and the firm faces uncertain appropriable benefits from the technological change two regulatory approaches are examined firstly we consider the quite common one of lowering the private investment cost through a subsidy in order to bridge the gap between the private and the policy maker s desired timing of environmental innovation secondly we consider a policy scenario where the regulator instead of simply lowering the investment s rental price also stimulates abandonment of the polluting technology by reducing through appropriate announcements the uncertainty surrounding the technological switch s private profitability we then compare the two approaches and show the latter s benefits in terms of the policy s effectiveness and or budgetary savings

the marginal efficiency effects of taxes and subsidies in the presence of externalities a computational general equilibrium approach abstract using 1983 data we develop a 19 sector computational general equilibrium model incorporating producer producer externalities and producer consumer externalities simulation results indicate that when additional government expenditure is financed by pigouvian taxes the marginal cost of public funds is substantially below one labor sales and output taxes also affect the output of the polluting industries and thus have indirect pigouvian effects which tend to reduce the associated marginal costs of public funds pigouvian taxes are usually more efficient than pigouvian subsidies since the tax revenue can be used to reduce other taxes

irreversible investment under uncertainty and the threat of bankruptcy abstract the firm level theory of irreversible investment under uncertainty is extended to account for bankruptcy with a sufficiently large risk of bankruptcy firms prefer to defer their investment decision to a later date simulated option values reach as high as 30 percent