Incomplete Information and Irreversible Investment

Jonathan Adams, Cheng Chen (), Min Fang, Takahiro Hattori () and Eugenio Rojas ()

No RWP 25-11, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: How do information frictions and investment frictions interact? We use a continuous-time model to analytically characterize how incomplete information distorts firms’ decision rules and stationary distribution when investment is irreversible. The two frictions interact in rich and substantial ways. At the firm level, noisier information shrinks a firm’s inaction region and reduces the elasticity of investment to productivity. In the aggregate, incomplete information increases steady-state capital, exacerbates capital misallocation, and mitigates the impact of productivity shocks on aggregate investment. We test and quantify these predictions using Japanese administrative data that match firms’ forecasts with their balance sheets, incomes, and expenditures. In the data, firms underreact to news as if they face information frictions; those with more extreme underreaction are less inactive, as predicted.

Keywords: heterogeneous firms; Incomplete information; irreversibility; heterogeneous beliefs; misallocation; investment; volatility (search for similar items in EconPapers)
JEL-codes: D25 D84 E22 E32 (search for similar items in EconPapers)
Pages: 67
Date: 2025-09-05
New Economics Papers: this item is included in nep-cfn
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedkrw:101729

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DOI: 10.18651/RWP2025-11

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