analytical solution for an investment problem under uncertainties with shocks abstract we derive the optimal investment decision in a project where both demand and investment cost are stochastic processes eventually subject to shocks we extend the approach used in dixit and pindyck 1994 to deal with two sources of uncertainty and we assume that the underlying processes are jump diffusion processes assuming certain conditions on the parameters we are able to derive a closed expression for the value of the firm finally we present comparative statics for the investment threshold with respect to the relevant parameters

valuing agricultural firms an examination of the contingent claims approach to pricing real assets abstract uncertainty about prices output demand and managerial decisions is not easily incorporated into a valuation model for real assets however techniques originally developed in the option pricing literature can accommodate these complexities this paper examines the contingent claims approach to valuing real assets a model for the value of an agricultural producer is derived optimal shutting and reopening volatile output and demand and other realistic features are included the model differs markedly from conventional discounted cash flow models empirical tests using prices of rubber and palm oil estates listed on the stock exchange of singapore offer some support for the model

the effect of political risk on the forward exchange bias the case of elections abstract the unsuccesful search for explanations of the forward bias has concentrated on variables suggested by traditional models of risk political news although important to foreign exchange traders has not been considered as a determinant of the forward bias i present a model in which the forward bias changes when the governing party changes elections in major industrial countries provide a natural test of the model the forward bias changed as predicted after half of the 13 elections in canada france the united kingdom and the united states between 1973 and 1985 politics provides useful information for foreign exchange traders which economists should not ignore

investment uncertainty and liquidity we analyze the dynamic investment decision of a firm subject to an endogenous financing constraint the threat of future funding shortfalls lowers the value of the firm s timing options and encourages acceleration of investment beyond the first best optimal level as well as highlighting another way by which capital market frictions can distort investment behavior this result implies that 1 the sensitivity of investment to cash flow can be greatest for high liquidity firms and 2 greater uncertainty has an ambiguous effect on investment

investment and uncertainty with time to build evidence from entry into u s copper mining abstract the standard real options model predicts that increased uncertainty discourages investment when projects are large and take time to build however that prediction can be reversed we investigate the investment uncertainty relationship empirically using historical data on opening dates of new u s copper mines large irreversible projects with substantial construction lags both the timing of the decision to go forward and the price thresholds that trigger that decision are assessed in particular we build upon a reduced form analysis to construct a structural model of entry we find that in this market greater uncertainty encourages investment and lowers the price thresholds for many mines

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

investor valuation of the abandonment option abstract we investigate whether investors price the option to abandon a firm at its exit value theory prices this real option as an american put with both a stochastic strike price exit value and a stochastic value of the underlying security the value of cash flows the empirical implications are that firm value increases in exit value after controlling for expected going concern cash flows and that more generalizable assets produce more abandonment option value using discounted earnings forecasts to proxy for expected cash flows and prior literature to categorize asset generalizability we find strong support for the predictions of abandonment option theory

the value of the option to wait and see abstract this note shows a very simple way to incorporate the effects of uncertainty about the accuracy of present value estimates into the firm s option to delay irreversible investment it is shown that if the firm s priors about the distribution of present value are sufficiently diffuse a reduction in the accuracy of present value estimates will increase the value of delay while learning will reduce its value

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

dynamic capacity planning using strategic slack valuation in this paper we analyze a particular aspect of capacity planning that is concerned with the active trading of production facilities for a homogenous product market we provide a theoretical rationale for the valuation and trading of these assets based on a metric of strategic slack we show that trading production assets with non additive portfolio profitability involves complex coordination with multiple equilibria and that these equilibria depend on the foresight in the planning horizon using the concept of strategic slack we have analyzed the dynamics of market structure the impact of asset trading on the level of production of the industry and to derive boundaries on the value of the traded assets moreover through computational learning the formulation is applied to a large oligopolistic electricity market showing that plant trading tends to lead to increased market concentration high prices lower production and a decrease in consumer surplus

the asymmetric impact of oil prices interest rates and oil price uncertainty on unemployment in the us abstract in this study we investigate the presence of asymmetric interactions between oil prices oil price uncertainty interest rates and unemployment in a cointegration framework utilizing the nonlinear auto regressive distributed lag nardl approach we show the asymmetric responses of unemployment to changes in oil prices oil price uncertainty and interest rates in the long run more specifically the results of our analyses suggest that an increase in oil price results in increased unemployment while there is no significant impact of reduced oil prices on the one hand reduced oil price uncertainty leads to a decrease in unemployment whereas an increase in oil price uncertainty does not have an impact we also observe increased unemployment in response to a decrease in interest rates as the impact of increased interest rates is not significant last but not least we find that option implied oil price volatility as a measure of oil price uncertainty outperforms the conditional volatility of crude oil prices in predicting unemployment this study provides valuable implications for policymakers to design sound economic policies

getting there exploring the role of expectations and preproduction delays in processes of organizational founding because of preproduction delays environmental conditions at founding cannot explain organization building decisions taken earlier as a consequence environmental conditions at founding cannot explain organizational founding future levels of resource availability may be estimated but not directly observed by potential entrepreneurs at the time at which they decide to enter preproduction in this paper we take these considerations as our starting point to build a dynamic feedback model of organization founding according to the model organizational founding is driven by expectations that entrepreneurs form about future levels of resources and only indirectly by current levels of population density we explore the behavior of the model under a variety of experimental conditions we show that the qualitative behavior of the model is consistent with studies that have linked the duration of preproduction stage with fluctuations in density during population maturity our simulation analyses sustains three main conclusions first historical trajectories of organizational populations that are consistent with empirical observations may be produced by mechanisms that are not directly dependent on density second alternative hypotheses about how expectations are formed produce qualitatively different historical trajectories of density third fluctuations in numbers of organizations are linked to specific aspects of individual organization building decisions

sequential investment in renewable energy technologies under policy uncertainty although innovation and support schemes are among the main forces that drive investment in renewable energy re technologies both involve considerable uncertainty we develop a real options framework to analyse the impact of technological policy and electricity price uncertainty on the decision to invest sequentially in successively improved versions of a re technology technological uncertainty is reflected in the random arrival of innovations and policy uncertainty in the likely provision or retraction of a subsidy that takes the form of a fixed premium on top of the electricity price we show that greater likelihood of subsidy retraction provision lowers raises the incentive to invest and by comparing a stepwise to a lumpy investment strategy we show how an embedded option to adopt an improved technology version mitigates the impact of subsidy retraction on investment timing specifically we show how stepwise investment facilitates earlier technology adoption compared to lumpy investment and that under stepwise investment technological uncertainty accelerates technology adoption thus further offsetting the incentive to delay investment in the light of subsidy retraction

globalization trade and migration undermining sustainability abstract i examine the impact of expanding international trade and migration on prospects for global sustainability from a strictly biophysical ecological behavioral perspective my starting premise is that techno industrial society is inherently unsustainable humans have a natural propensity to expand to occupy all accessible habitats and use all available resources because of continuous growth propelled by improving technology the modern human enterprise is already in a state of ecological overshoot globalization and trade exacerbate the situation by shuffling resources around and short circuiting the negative feedback that would otherwise result from local resource degradation this allows population and material growth within each individual trading region to exceed local biophysical limits this in turn accelerates the depletion of natural capital everywhere and ensures that all now trade dependent regions hit global limits simultaneously large scale migration also worsens matters by reducing negative feedback and enabling increased resource consumption moreover because resource scarcity is likely to precipitate conflict among self identifying tribal groups within multi cultural societies uncontrolled migration may create conditions that impede the implementation of policy measures required for ecological sustainability global sustainability is thus most likely to be achieved through policies that foster increased regional self reliance encourage greater investment in local natural capital and favor the development of strong diverse local economies in place such measures will raise local and therefore global bio capacities and reduce both the pull and push factors in international migration

time to build option value and investment decisions a comment abstract we correct the analysis of the model of time to build in majd and pindyck 1987 journal of financial economics 18 7 27 for the omission of an essential optimality condition our analysis reveals an additional insight long times to build reduce the effects of increased project value volatility i e higher investment thresholds in comparison to standard real option models of investment under uncertainty where investment is instantaneous thus a naive npv rule can sometimes be an appropriate initial guide to investment

valuing flexibility as a complex option this paper develops an approach for valuing flexible production systems using contingent claims pricing demand curves for our model s underlying assets output products may be downward sloping in contrast with the standard option pricing assumption also our marginal production exercise costs may be increasing in addition we allow for multiple products and a production capacity constraint these elements of the model result in complex exercise decisions for the contingent claims which comprise the production system s value we illustrate our approach by valuing a flexible system that produces two products which have profit margin functions with stochastic parameters

stochastic intertemporal duality an application to investment under uncertainty abstract we present a duality concept for a class of stochastic dynamic optimization problems that especially includes models of investment under uncertainty this concept allows us to derive explicit characterizations of optimal investment behavior from an adjustment cost model with expectations described by linear or nonlinear stochastic processes it covers settings that are impenetrable with a direct approach like expectations with a multimodal density or certain forms of non convex technologies

an option pricing approach to evaluating petroleum projects abstract option pricing applications in capital budgeting decisions are still in the development stage this paper uses concepts and methods from option pricing theory to evaluate real projects rather than financial ones within a petroleum projects context such real options include development and operations of satellite fields break even values of incremental capacity and flexibility value with compound development and operations options the option pricing results may be quite different from those obtained by traditional capital budgeting and decision tree approaches some related papers on real options are also briefly noted

time to build and the real options channel of residential investment abstract a standard real options model predicts that time to build investment could be delayed by uncertainty over future revenue we quantify the first order importance of this mechanism in the 2002 2011 housing boom bust cycle by developing and estimating a model of sequential irreversible investment with stochastic bottlenecks we find that the main driver of construction delays during the boom is construction bottlenecks however further delay in construction during the bust is caused by an increase in uncertainty which grew by 21 6 between 2002 and 2009 the model can account for more than one third of the decline in residential investment between 2002 and 2009

continuous time methods in finance a review and an assessment i survey and assess the development of continuous time methods in finance during the last 30 years the subperiod 1969 to 1980 saw a dizzying pace of development with seminal ideas in derivatives securities pricing term structure theory asset pricing and optimal consumption and portfolio choices during the period 1981 to 1999 the theory has been extended and modified to better explain empirical regularities in various subfields of finance this latter subperiod has seen significant progress in econometric theory computational and estimation methods to test and implement continuous time models capital market frictions and bargaining issues are being increasingly incorporated in continuous time theory the roots of modern continuous time methods in finance can be traced back to the seminal contributions of merton 1969 1971 1973b in the late 1960s and early 1970s merton 1969 pioneered the use of continuous time modeling in financial economics by formulating the intertemporal consumption and portfolio choice problem of an investor in a stochastic dynamic programming setting merton 1973b also showed how such a framework can be used to develop equilibrium asset pricing implications thereby significantly extending the asset pricing theory to richer dynamic settings and expanding the scope of applications of continuous time methods to study problems in financial economics 1 within a span of about 30 years from the publication of merton s inf luential papers continuous time methods have become an integral part of financial economics indeed in certain core areas in finance such as e g asset pricing derivatives valuation term structure theory and portfolio selection continuoustime methods have proved to be the most attractive way to conduct research and gain economic intuition the continuous time approach in these areas has produced models with a rich variety of testable implications the econometric theory for testing continuous time models has made rapid strides in the last decade and has thus kept pace with the impressive progress on the theoretical front one hopes that the actual empirical investigations and estimation using the new procedures will follow suit soon

pricing american style securities using simulation abstract we develop a simulation algorithm for estimating the prices of american style securities i e securities with opportunities for early exercise our algorithm provides both point estimates and error bounds for the true security price it generates two estimates one biased high and one biased low both asymptotically unbiased and converging to the true price combining the two estimators yields a confidence interval for the true price the proposed algorithm is especially attractive compared with lattice and finite difference methods when there are multiple state variables and a small number of exercise opportunities preliminary computational evidence is given

taking an option on the future subsidizing biofuels for energy security or reducing global warming abstract this paper examines the biofuels industry from a policy and international trade perspective across the globe there are two main public policy objectives driving the development of biofuels industries improving energy security and reducing global warming the us and canadian governments have respectively fostered biofuels industries for these reasons as biofuels industries will not be financially viable without government support in the foreseeable future government policies can be interpreted as taking options on the future a theoretical model is developed using option value theory to determine whether the same governmental policy subsidization can lead to different levels of optimal subsidies in each country where the subsidy policy is driven by two distinct motivating factors if the reason subsidy levels differ is structural the likelihood of a trade dispute arising increases

capital budgeting under uncertainty an integrated approach using contingent claims analysis and integer programming recently the application of contingent claims analysis and dynamic programming to project evaluation has attracted a lot of attention these techniques are required for example if the value of a project develops stochastically over time and the decision to invest into this project can be postponed yet so far there are no considerations regarding how this perception of projects reflects on a capital budgeting situation we propose two approaches that integrate these methods with traditional capital budgeting models a simple capital budgeting model can be formulated as the problem of finding the portfolio of options that has maximal value and fulfils the capital expenditure constraint however this model has some shortcomings regarding its applicability in traditional budgeting situations therefore we define an alternative optimisation model that uses scenarios to depict a set of possible future states the optimal portfolio is then equivalent to a dynamic investment strategy that determines a number of state dependent optimal portfolios

the impact of investment lags on investment decision abstract this paper suggests a valuation framework for an investment project through the concept of real options generally in real asset world decision time and its payment time are not identical this so called investment lag problem should be considered when valuing real assets when investment lags exist firms accommodation capacities play important roles in this paper the real effect of investment lag on investment value is tested upon various conditions we show the valuation process of real assets under the risk neutral world the closed form formula is also provided for valuing real assets including r d project

hysteresis due to irreversible exit addressing the option to mothball abstract this paper analyses the following hitherto understudied feature in real switching options a firm has a mothballing option and an option to permanently abandon if the firm finds itself in an operating mode with a price just above the abandonment threshold it is unclear whether to exercise the abandonment option or to exercise the mothballing option if the price goes down the firm may exit but surprisingly if it goes up it may mothball we find that two different strategies could be optimal one where mothballing is not a viable option and one where mothballing does occur in the latter case a hysteresis region arises in which the firm produces at a loss while a further price decrease induces exit and a sufficient price increase results in the firm entering the mothballing stage mothballing being optimal requires sufficiently large values of the price trend and the uncertainty parameter

optimal investment under operational flexibility risk aversion and uncertainty traditional real options analysis addresses the problem of investment under uncertainty assuming a risk neutral decision maker and complete markets in reality however decision makers are often risk averse and markets are incomplete we confirm that risk aversion lowers the probability of investment and demonstrate how this effect can be mitigated by incorporating operational flexibility in the form of embedded suspension and resumption options although such options facilitate investment we find that the likelihood of investing is still lower compared to the risk neutral case risk aversion also increases the likelihood that the project will be abandoned although this effect is less pronounced finally we illustrate the impact of risk aversion on the optimal suspension and resumption thresholds and the interaction among risk aversion volatility and optimal decision thresholds under complete operational flexibility

timing and eco nomic efficiency of climate friendly investments in supply chains abstract emission trading schemes such as the european union emissions trading system euets attempt to reconcile economic efficiency with ecological efficiency by creating financial incentives for companies to invest in climate friendly innovations using real options methodology we demonstrate that under uncertainty economic and ecological efficiency continue to be mutually exclusive this problem is even worse if a climate friendly project depends on investing in of a whole supply chain we model a sequential bargaining game in a supply chain where the parties negotiate over implementation of a carbon dioxide co2 saving investment project we show that the outcome of their bargaining is not economically efficient and even less ecologically efficient furthermore we show that a supply chain becomes less economically efficient and less ecologically efficient with every additional chain link finally we make recommendations for how managers or politicians can improve the situation and thereby increase economic as well as ecological efficiency and thus also the eco efficiency of supply chains

fixed versus flexible production systems a real options analysis in this work we address investment decisions in production systems by using real options as is standard in literature the stochastic variable is assumed to be normally distributed and then approximated by a binomial distribution resulting in a binomial lattice the methodology establishes a discrete valued lattice of possible future values of the underlying stochastic variable demand in our case and then computes the project value we have developed and implemented stochastic dynamic programming models both for fixed and flexible capacity systems in the former case we consider three standard options the option to postpone investment the option to abandon investment and the option to temporarily shut down production for the latter case we introduce the option of corrective action in terms of production capacity that the management can take during the project by considering the existence of one of the following i a capacity expansion option ii a capacity contraction option or iii an option considering both expansion and contraction the full flexible capacity model where both the contraction and expansion options exist leads as expected to a better project predicted value and thus investment policy however we have also found that the capacity strategy obtained from the flexible capacity model when applied to specific demand data series often does not lead to a better investment decision this might seem surprising at first but it can be explained by the inaccuracy of the binomial model the binomial model tends to undervalue future decreases in the stochastic variable demand while at the same time tending to overvalue an increase in future demand values

how economic growth becomes a cost the scarcity multiplier competent macro allocation of natural capital would allow micro allocation by economics to be fully useful and may help prevent the latter being confused with the former this macro allocation requires social choice so to see whether it is likely to be competent the effectiveness of democratic politics is investigated dysfunction is predicted because democratic institutions produce elements of irresponsibility and ignorance these permit inflation of want by supply iws a positive feedback in which wants are increased by their supply provoking more supply hence more want four iws systems combine under common conditions to indefinitely escalate the scarcity of natural capital a crucial failure of macro allocation this scarcity multiplier causes apparently rational attempts to satisfy a few wants to exacerbate many increasing dissatisfaction institutions for deliberative public participation may enable democracies to recognize and control iws unless this is done the scarcity multiplier may make cost benefit analysis misleading it may make the costs of development projects exceed their benefits in proportion to their financial success

the impact of lead time on capital investments abstract we study equilibrium investment strategies of firms competing in stochastic dynamic market settings and facing two types of investment structures investment with significant lead time or time to build and investment without or minor lead time we investigate how investment behavior changes when investment is subject to time to build versus when it is not we characterize equilibrium investment strategies under several information structures and compare results to the social optimum we offer some new results the model predicts that controlling for demand and production and investment costs investments and outputs can be higher in progressive industries which often exhibit time to build than in fast paced industries where time to build is insignificant furthermore for both investment types investment with or without time to build we offer a novel equilibrium in which firms incrementally invest this behavior is driven by demand uncertainty and capacity constraints also expected outputs are lower than cournot outputs as firms face uncertainty moreover the amount of uncertainty has different effects over investment types

optimal sequential investment when capital is not readily reversible when investment opportunities arrive one at a time and are reviewed sequentially a corporation s optimal policy differs from a standard net present value rule if the corporation exercises control over an industry state variable and control is costly the first condition presupposes a degree of market power for the firm the second occurs if corporate investment decisions are imperfectly reversible to address the problem of optimal investment in this context a firm s investment decisions are modeled as a markov reward process the causes of economic irreversibility are discussed and general propositions concerning the optimal investment policy are derived these propositions are then applied to the optimization of an exploration program by an oligopolistic firm a price leader under particular demand and distributional assumptions solutions for the optimal decision rule and the value of the exploration program are obtained and their properties examined current investment may affect future opportunities by creating growth opportunities as defined by myers 16 see also spence 25 or by reducing the value of an existing opportunity set despite the known potential for these interactions capital budgeting techniques such as net present valuation scenario planning and monte carlo simulation focus exclusively on the stand alone value of an investment the capacity for modeling interactions is present in the multiperiod models of merton 16 bogue and roll 5 and others the absence of applications however is evidence that actual economic interactions between current and future opportunities are not well understood this paper develops a model of a firm facing a sequence of interdependent growth opportunities opportunities have positive net present values because the firm exercises market power in its product market current investment changes the value of future opportunities through its effect on a product market variable the model is used to examine the impact of demand industry structure and technology on optimal investment rules and on the value of aggregate growth

a bayesian approach to real options the case of distinguishing between temporary and permanent shocks traditional real options models demonstrate the importance of the option to wait due to uncertainty over future shocks to project cash flows however there is often another important source of uncertainty uncertainty over the permanence of past shocks adding bayesian uncertainty over the permanence of past shocks augments the traditional option to wait with an additional option to learn the implied investment behavior differs significantly from that in standard models for example investment may occur at a time of stable or decreasing cash flows respond sluggishly to cash flow shocks and depend on the timing of project cash flows during the past two decades the real options approach to valuation of irreversible investment opportunities has become part of the mainstream literature in financial economics the central idea is that the opportunity to invest is equivalent to an american call option on the underlying investment project as a consequence the problem of optimal investment timing is analogous to the optimal exercise decision for an american option applications of the real options approach are now numerous 1 one feature that is common to virtually all real options models is that the underlying uncertainty pertains only to future shocks since future cash flows are uncertain there is an important opportunity cost of investing today the value of the asset might go up so that tomorrow will be an even better time to invest this opportunity cost is often referred to in the literature as the option

interactions of corporate financing and investment decisions a dynamic framework this article analyzes the interaction between a firm s dynamic investment operating and financing decisions in a model with operating adjustment and recapitalization costs using numerical analysis we solve the model for cases that highlight interaction effects we find that higher production flexibility due to lower costs of shutting down and reopening a production facility enhances the firm s debt capacity thereby increasing the net tax shield value of debt financing while higher financial flexibility resulting from lower recapitalization costs has a similar effect production flexibility and financial flexibility are to some extent substitutes we find that the impact of debt financing on the firm s investment and operating decisions is economically insignificant

remittances and the migration development nexus challenges for the sustainable governance of migration abstract this paper argues that possible effects of international migration on the environment have to be analysed with respect to both the three dimensions of sustainability and the migration stakeholders it has recently been put forward that immigration has to be reduced for environmental reasons in contrast this paper embarks from the view that reducing immigration is costly ineffective and ethically troublesome it argues that there are strong interrelations between development and migration suggesting that one has to consider development problems when discussing migration in this context the enormous amount of remittances of migrant workers could yield considerable potential for promoting sustainable development sustainable governance is needed to manage this potential wisely in doing so it is essential to consider the migration stakeholders sending and receiving countries and the migrants themselves and balance the three dimensions of sustainability

the intensity and timing of investment the case of land the authors model the decision to replace durable capital when intensity is variable decisions of this type include land redevelopment decisions where the density of residential or commercial development is a choice variable as well as capital replacement decisions where capacity is variable the authors provide a general yet simple formation of the problem using an optimal stopping framework they characterize the value of the project the timing of investment and the intensity of development the authors show that intensity interacts in important ways with timing taxes and project values the ability to vary intensity raises hurdle rents and delays development decisions copyright 1994 by american economic association

finite project life and uncertainty effects on investment abstract this paper revisits the important result of the real options approach to investment under uncertainty which states that increased uncertainty raises the value of waiting and thus decelerates investment typically in this literature projects are assumed to be perpetual however in today s economy firms face a fast changing technology environment implying that investment projects are usually considered to have a finite life the present paper studies investment projects with finite project life and we find that in contrast with the existing theory investments may be accelerated by increased uncertainty it is shown that this particularly happens at low levels of uncertainty and when project life is short

the learning curve and optimal production under uncertainty this article examines the implications of the learning curve in a world of uncertainty we consider a competitive firm whose costs decline with cumulative output because the price of the firm s output evolves stochastically future production and cumulative output are unknown and are contingent on future prices and costs we derive an optimal decision rule that maximizes the firm s market value produce when the price exceeds a critical level which is a declining function of cumulative output we show how the shadow value of cumulative production the total value of the firm and the decision to produce depend on the volatility of the price and other parameters uncertainty increases the critical price required for the firm to produce but also increases the value of thefirm thus during periods of high volatility firms facing a learning curve ought to be producing less but are worth more

option valuation of claims on real assets the case of offshore petroleum leases this paper extends financial option theory by developing a methodology for the valuation of claims on a real asset an offshore petroleum lease several theoretical and practical problems not present in applying option pricing theory to financial assets are addressed most importantly we show the necessity of combining option pricing techniques with a model of equilibrium in the market for the underlying asset petroleum reserves the advantages of this approach over conventional discounted cash flow techniques are emphasized the methodological development provides important insights for both company behavior and government policy promising empirical results are reported

investment in general training the role of information and labour mobility following the seminal work of becker i964 it is widely accepted in the literature that firms will be unwilling to finance training which workers may use in other firms this paper takes issue with this prediction and suggests that firms will frequently share in the cost of such general training 1 becker argues that a firm which pays for the training of workers in skills of potential use to other firms will lose these workers since other firms bear none of the costs of general training they can attract a worker with such training by outbidding the firm which trained him recognising this absence of property rights over an investment in general training firms will refuse to provide it hence if general training is to take place the trainee will have to pay for it if potential trainees are unwilling or unable to pay general training will not take place a shortage in general training is likely to emerge this may be especially pronounced in developing countries 2 in contrast the outlook for

oil price uncertainty in canada bernanke bernanke ben s irreversibility uncertainty and cyclical investment quarterly journal of economics 98 1983 85 106 shows how uncertainty about energy prices may induce optimizing firms to postpone investment decisions thereby leading to a decline in aggregate output elder and serletis elder john and serletis apostolos oil price uncertainty http ssrn com abstract 908675 2009 find empirical evidence that uncertainty about oil prices has tended to depress investment in the united states in this paper we assess the robustness of these results by investigating the effects of oil price uncertainty in canada our results are remarkably similar to existing results for the united states providing additional evidence that uncertainty about oil prices may provide another explanation for why the sharp oil price declines of 1985 failed to produce rapid output growth impulse response analysis suggests that uncertainty about oil prices may tend to reinforce the negative response of output to positive oil shocks

long live democracy the determinants of political instability in latin america abstract we investigate the underlying causes of political instability in a panel of 18 latin american countries from 1971 2000 we test whether regime type regime durability factionalism income inequality ethnic diversity ethnic discrimination regional spillover effects urban growth and macroeconomic variables matter for instability we find several important results 1 democracy has a significant negative effect on instability that is robust to several alternative specifications 2 factionalised political systems experience higher instability 3 income inequality ethnic fractionalisation and urban growth have important nonlinear effects on instability and 4 of the macroeconomic variables we study only openness to trade has a significant negative effect on instability

investment flexibility as a barrier to entry abstract this paper presents a model of investment in a duopoly with firms that choose the scale and timing of investment decision making flexibility and the costs saved by investing in large steps rather than sequences of small steps determine an incumbent s ability to deter entry by a potential competitor entry occurs when these cost savings are very small or very large because the effect of increased industry capacity on the incumbent s assets in place is the same regardless of which firm invests in intermediate cases the incumbent is able to deter entry by making a smaller earlier investment than the potential entrant the smaller investment scale protects the incumbent s assets in place which offsets the incumbent s cost disadvantage from investing in smaller steps than the entrant would choose nevertheless the threat of entry constrains the incumbent s investment behavior and limits its profitability the model is solved using a combination of best response iteration and the projected successive over relaxation method

option value uncertainty and the investment decision the options based approach to studying irreversible investment under uncertainty emphasizes that the opportunity cost of investment includes the value of the option to wait that is extinguished when an investment is undertaken thus the investment decision is affected by the determinants of the value of this option we extend and generalize a standard model of irreversible investment by introducing a second fully reversible technology and also incorporate partial reversibility by allowing capital to be abandoned at a cost as in the existing literature we find that the threshold value of the underlying asset in our case demand at which investment takes place is increasing in the uncertainty of demand we also find that the value of the option and thus the threshold value of the option value multiple at which investment takes place may be either increasing or decreasing in the uncertainty of demand in addition we find that for the case in which capital is used to replace the reversible technology the threshold value of the option value multiple is insensitive to the degree of reversibility of capital

complementary system perspectives in ecological macroeconomics the example of transition investments during the crisis globally societies are facing a number of interrelated environmental economic and social crises this paper is intended to contribute to the development of an ecological macroeconomics that addresses these multiple crises in combination insights from different research communities will be included in this effort taking an ecological economic understanding of sustainability as the point of departure and inspired by systems thinking it is discussed which economic sub systems should be in focus for sustainability transitions and whether relevant guides for sustainability can be formulated for these systems in particular the focus is on systems that are decisive for resource consumption and pollution although their influence on these is indirect a simple typology of sub systems is suggested and applied in relation to an example that highlights the importance of the interplay between macroeconomic provision and distribution systems the example concerns investments in sustainability transitions of provision systems and demonstrates the complexities of implementing such transformations during the economic crisis it also addresses the need for ecological macroeconomics to develop a third position beyond austerity policies and keynesian approaches

time to build and fluctuations in bulk shipping abstract this paper explores the nature of fluctuations in world bulk shipping by quantifying the impact of time to build and demand uncertainty on investment and prices we examine the impact of both construction lags and their lengthening in periods of high investment activity by constructing a dynamic model of ship entry and exit a rich dataset of secondhand ship sales allows for a new estimation strategy resale prices provide direct information on value functions and allow their nonparametric estimation we find that moving from time varying to constant to no time to build reduces prices while significantly increasing both the level and volatility of investment jel g31 l11 l62 l92

capacity expansion for random exponential demand growth with lead times the combination of demand uncertainty and a lead time for adding capacity creates the risk of capacity shortage during the lead time we formulate a model of capacity expansion for uncertain exponential demand growth and deterministic expansion lead times when there is an obligation to provide a specified level of service the service level defined in terms of the ratio of expected lead time shortage to installed capacity is guaranteed by timing each expansion to begin when demand reaches a fixed proportion of the capacity position under this timing rule the optimal facilities to install can be determined by solving an equivalent deterministic problem without lead times numerical results show the effects of the demand parameters and lead time length on the expansion timing the interaction of timing with expansion size is explored for the case when continuous facility sizes are available with economies of scale

a compound option model of production and intermediate inventories this article extends the option approach to valuing real assets by modeling the firm as a two stage process with bounded output rates in which the output of the first stage may be held as work in process in this setting the real asset becomes a compound option which if exercised gives the option to finish the work in process and sell the output as its final payoff the existence of intermediate inventories may arise as an optimal investment strategy for exploiting possible future price increases the framework allows us to analyze the effect of uncertainty on output rates and the effect of interest rates changes on inventory levels copyright 1993 by university of chicago press

governance and uncertainty the trade off between administrative control and commitment this study elaborates upon the motives for initiating equity based collaborations vs acquisition of another firm already having a desired technology we characterize both minority direct investments and joint ventures as options to defer either internal development or acquisition of a target firm in domains where learning about growth opportunities dominates investment activity this incremental mode of governance economizes on the cost of committing resources to a technology with an uncertain value using a sample of 402 transactions in the biotechnology industry we find strong support for the theoretical model the findings suggest that the cost of commitment in the face of technological uncertainty may offset the administrative benefits of hierarchical governance 1998 john wiley sons ltd

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

explicit investment rules with time to build and uncertainty abstract 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

macroeconomic narratives in a world of crises an analysis of stories about solving the system crisis since the financial crisis in 2008 a series of publications on macroeconomic responses to the compound crises of the economy and the environment have emerged under labels such as green new deal green growth and the great transition attempts at offering coherent responses to the crises have been made these responses have in common that they all present a large number of policy proposals for ways in which to solve the current crises and achieve a sustainable economy this article provides a mapping of a selection of such responses and an analysis of their content the analysis combines discourse theory and narrative analysis and investigates discourses by studying the narratives they produce the study thus contributes to the long line of analyses on discourses on sustainable economy empirically by investigating and analysing a number of macroeconomic proposals for solving the system crisis and theoretically by elaborating on the concept of narrative dynamics in relation to persuasive strength in political decision making

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

optimal investment in ecological rehabilitation under climate change ecological rehabilitation is subject to a variety of risks affecting the likely return on investment we propose an options approach to allocating scarce conservation funds that explicitly allows for the irreversibility of investment and risks to investment payoffs the approach captures ecosystem dynamics from extinction debt as well as ecological and climatic risks at the project scale climatic risks are introduced through three channels the effects of climate change on species loss future rehabilitation benefits and frequency of catastrophic events our results suggest that allocating voluntary rehabilitation contracts on the basis of real options criteria increases cost efficiency and delivers greater value for money for the government when compared with the conventional cost effectiveness criterion as it is illustrated for the case of box gum grassy woodland rehabilitation in australia

exchange rate volatility international trade and the value of exporting firms abstract increased exchange rate volatility positively affects the value of exporting firms via the price and volume impacts of exchange rates and also makes an exporting strategy more attractive relative to the direct investment investment in export production capacity could therefore be a positive function of exchange rate volatility firms would also be more willing to sustain losses i e to engage in dumping before they abandon their export markets the effect on the volume and value of trade is ambiguous

project management under risk using the real options approach to evaluate flexibility in r d managerial flexibility has value in the context of uncertain r d projects as management can repeatedly gather information about uncertain project and market characteristics and based on this information change its course of action this value is now well accepted and referred to as real option value we introduce in addition to the familiar real option of abandonment the option of corrective action that management can take during the project the intuition from options pricing theory is that higher uncertainty in project payoffs increases the real option value of managerial decision flexibility however r d managers face uncertainty not only in payoffs but also from many other sources we identify five example types of r d uncertainty in market payoffs project budgets product performance market requirements and project schedules how do they influence the value from managerial flexibility we find that if uncertainty is resolved or costs revenues occurafter all decisions have been made more variability may smear out contingencies and thus reduce the value of flexibility in addition variability may reduce the probability of flexibility ever being exercised which also reduces its value this result runs counter to established option pricing theory intuition and contributes to a better risk management in r d projects our model builds intuition for r d managers as to when it is and when it is not worthwhile to delay commitments for example by postponing a design freeze thus maintaining flexibility in r d projects

the option value of advanced r d existing tools for making r d investment decisions cannot properly capture the option value in r d since many new products are identified as failures during the r d stages the possibility of refraining from market introduction may add a significant value to the npv of the r d project this paper presents new theoretical insight by developing a stochastic jump amplitude model in a real setting the option value of the proposed model depends on the expected number of jumps and the expected size of the jumps in a particular business the model is verified with empirical knowledge of current research in the field of multimedia at philips corporate research this way the gap between real option theory and the practice of decision making with respect to investments in r d is diminished

investments of uncertain cost abstract this paper examines irreversible investment decisions when projects take time to complete and are subject to two types of cost uncertainty the first is technical uncertainty i e uncertainty over the physical difficulty of completing a project which is only resolved as the investment proceeds the second is input cost uncertainty i e uncertainty over the prices of construction inputs or over government regulations affecting construction costs which is external to the firm these two types of uncertainty have very different effects on the investment decision a simple investment rule is derived that maximizes firm value and is used to analyze the decision to start or continue building a nuclear power plant during the 1980s

real options and product life cycles in this paper i develop an option valuation framework that explicitly incorporates a product life cycle i then use the framework to value the real option to change a project s capacity standard techniques for valuing real options typically ignore product life cycle models and specify instead a constant expected growth rate for demand or price i show that this specification can lead to significant error in the valuation of capacity options in particular the standard technique tends to undervalue the option to contract capacity and overvalue the option to expand capacity this result has important implications for capital investment decisions especially in high technology industries that feature regular introductions of newly improved products

flexibility premium of emissions permits abstract investments in abatement technology are often characterised by irreversibility and significant implementation lags whereas emissions permits can be traded at any time as such abatement and emissions permit trading systems are hardly perfect substitutes we formally study the flexibility of emissions permits and propose a unified framework to rationalise the impact of both investment divestment lags and irreversibility in relation to the price of emissions permits using option pricing concepts we reformulate the technology adoption problem in terms of the technology s characteristics irreversibility and implementation lags and offer a conceptual quantification of the flexibility premium of emissions permits

time to build option value and investment decisions abstract investment decisions and outlays are often made sequentially for example the rate at which construction proceeds is usually flexible and can be adjusted with the arrival of new information traditional discounted cash flow methods which treat the pattern of investment as fixed ignore this flexibility and understate the value of the project this paper uses contingent claims analysis to derive optimal decision rules and to value such investments we determine the effects of time to build opportunity cost and uncertainty on the investment decision for reasonable parameter values we show how a simple npv rule can lead to gross errors

strategic entry and market leadership in a two player real options game abstract we analyse the entry decisions of competing firms in a two player stochastic real option game when rivals earn different but correlated uncertain profitabilities from operating in the presence of entry costs decision thresholds exhibit hysteresis the range of which is decreasing in the correlation between competing firms a measure of the expected time of each firm being active in the market and the probability of both rivals entering within a finite time are explicitly calculated the former latter is found to decrease increase with the volatility of relative firm profitabilities implying that market leadership is shorter lived the more uncertain the industry environment in an application of the model to the aircraft industry we find that boeing s optimal response to airbus launch of the a380 super carrier is to accommodate entry and supplement its current product line as opposed to the riskier alternative of committing to the development of a corresponding super jumbo

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

time to build and investment the paper investigates the effect of the time to build technology on investment dynamics it explains the positive autocorrelation of investment by showing that investment is serially correlated once the time to build technology is taken into account the paper also shows that the time to build technology can explain a substantial portion of the variation in aggregate investment data using estimated marginal q the paper illustrates that investment responds asymmetrically to different levels of q a fact in favor of the irreversibility argument