Explicit investment rules with time-to-build and uncertainty

René Aïd, Salvatore Federico (), Huyên Pham and Bertrand Villeneuve

Journal of Economic Dynamics and Control, 2015, vol. 51, issue C, 240-256

Abstract: We establish explicit socially optimal rules for an irreversible investment decision with time-to-build and uncertainty. Assuming a price sensitive demand function with a random intercept, we provide comparative statics and economic interpretations for three models of demand (arithmetic Brownian, geometric Brownian, and the Cox–Ingersoll–Ross). Committed capacity, that is, the installed capacity plus the investment in the pipeline, must never drop below the best predictor of future demand, minus two biases. The discounting bias takes into account the fact that investment is paid upfront for future use; the precautionary bias multiplies a type of risk aversion index by the local volatility. Relying on the analytical forms, we discuss in detail the economic effects. For example, the impact of volatility on the optimal investment is negligible in some cases. It vanishes in the CIR model for long delays, and in the GBM model for high discount rates.

Keywords: Optimal capacity; Irreversible investments; Singular stochastic control; Time-to-build; Delay equations (search for similar items in EconPapers)
JEL-codes: C61 D92 E22 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0165188914002875
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Explicit investment rules with time-to-build and uncertainty (2014)
Working Paper: Explicit investment rules with time-to-build and uncertainty (2014)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:51:y:2015:i:c:p:240-256

DOI: 10.1016/j.jedc.2014.10.010

Access Statistics for this article

Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Catherine Liu ().