Irreversible investment and capacity choice with Bayesian learning

Fan Hu, Yaoyao Wu and Lei Zhou

The North American Journal of Economics and Finance, 2022, vol. 63, issue C

Abstract: This paper incorporates information incompleteness into the standard capacity choice model. The firm dynamically updates its belief about the expected growth rate based on the realization of demand shocks. First, the firm’s expansion decision becomes more conservative in the dynamic updating case. Moreover, a myopic firm always overestimates the marginal value of capital but underestimates firm value. When we decompose the firm value into the value of assets in place and growth opportunities, dynamic learning significantly increases the value of growth opportunities rather than that of assets in place. Finally, the implications for the user cost of capital is also examined.

Keywords: Irreversible investment; Capacity choice; Incomplete information; Dynamic learning (search for similar items in EconPapers)
JEL-codes: D83 E22 G31 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:63:y:2022:i:c:s1062940822001504

DOI: 10.1016/j.najef.2022.101815

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