The Implications of Parameter Uncertainty for Irreversible Investment Decision

Michael Sampson

Canadian Journal of Economics, 1998, vol. 31, issue 4, 900-914

Abstract: The author examines the effect of unknown expected growth rates on irreversible investment decisions. With parameter uncertainty, it may be optimal in some periods to delay investment no matter what the current value of the project in order to collect more data on the unknown parameter. The author argues this may explain downturns in investment associated with changes in regime. In those periods where investment is possible, parameter uncertainty introduces an upper threshold into the optimal investment rule. Thus, investment may be delayed because the value of the project is too high. A numerical illustration of these results is provided.

Date: 1998
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