Uncertainty and the trade-off between scale and flexibility in investment

Graeme Guthrie

Journal of Economic Dynamics and Control, 2012, vol. 36, issue 11, 1718-1728

Abstract: This paper analyzes the behavior of a firm that chooses both the scale and timing of its investment. Sensitivity analysis shows that greater demand volatility is associated with the firm investing in larger increments, less frequently. This is in contrast to the conventional wisdom, which is that greater volatility leads to investment in smaller increments, more frequently. Overall, the reduced frequency dominates the greater scale, so that the long-run average rate of investment is a decreasing function of demand volatility. The timing and scale of investment are most sensitive to volatility when there are substantial investment economies of scale.

Keywords: Investment; Uncertainty; Real options; Economies of scale (search for similar items in EconPapers)
JEL-codes: D21 D92 G31 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:36:y:2012:i:11:p:1718-1728

DOI: 10.1016/j.jedc.2012.04.008

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