Investment decisions with finite-lived collars

Roger Adkins, Dean Paxson, Paulo J. Pereira and Artur Rodrigues

Journal of Economic Dynamics and Control, 2019, vol. 103, issue C, 185-204

Abstract: The duration of most collar arrangements provided by governments to encourage early investment in infrastructure, renewable energy facilities, or other projects with social objectives are finite, not perpetual. We extend the previous literature on collar-style arrangements by providing an analytical solution for the idle and active values, as well as the investment triggers, for projects where collars are either finite-lived or retractable. What is the difference between these types of arrangements with their perpetual counterpart? Lots, including different vega signs, and substantially different values for different current price levels. Often, finite and retractable collars justify earlier investment timing than perpetual collars. In general, we demonstrate that the finite-lived and retractable versions have a significant impact on optimal behavior, relative to the perpetual case. An important consideration when negotiating the floors, ceilings, and duration (or signalling the expected duration) of a finite or a retractable collar is the current price level of the output and its expected volatility over the life of the contract.

Keywords: Finite collars; Perpetual collars; Retractable collars; Investment opportunities (search for similar items in EconPapers)
JEL-codes: D81 G31 H25 Q48 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:103:y:2019:i:c:p:185-204

DOI: 10.1016/j.jedc.2019.04.008

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