Irreversibility, Uncertainty, and Investment

The ability to delay an irreversible investment expenditure can profoundly affect the decision to invest. It also undermines the theoretical foundation of standard neoclassical investment models. Irreversibility may have important implications for the understanding of aggregate investment behavior....

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Bibliographic Details
Published in:Journal of economic literature 1991-09, Vol.29 (3), p.1110-1148
Main Author: Pindyck, Robert S.
Format: Article
Language:English
Subjects:
Applications
Capital investments
Economic models
Economic theory
Economic uncertainty
Financial investments
Institutional investments
Investment decisions
Investment policy
Investment return rates
Investment value
Investments
Net present value
Opportunity costs
Options trading
Portfolio investments
Prices
Studies
Sunk costs
Uncertainty
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Summary:The ability to delay an irreversible investment expenditure can profoundly affect the decision to invest. It also undermines the theoretical foundation of standard neoclassical investment models. Irreversibility may have important implications for the understanding of aggregate investment behavior. It makes investment especially sensitive to various forms of risk, such as uncertainty over the future product prices and operating costs that determine cash flows, uncertainty over future interest rates, and uncertainty over the cost and timing of the investment itself. Consequently, irreversibility may have implications for macroeconomic policy. Some basic models of irreversible investment are reviewed to illustrate the option-like characteristics of investment opportunities. The models show how the resulting investment rules depend on various parameters from the market environment. Recent applications of this methodology to a variety of investment problems are surveyed.
ISSN:0022-0515
2328-8175