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A model of capacity choice under Knightian uncertainty

Yingjie Niu, Lei Zhou and Zhentao Zou

Economics Letters, 2019, vol. 174, issue C, 189-194

Abstract: This paper introduces Knightian uncertainty into the standard model of capacity choice and investigates its impact on the firm’s expansion decision. First, we find Knightian uncertainty reduces both the firm value and marginal value of capital. Under Knightian uncertainty, the firm’s expansion decision is shown to be more conservative. When the firm value is decomposed into the value of assets in place and growth opportunities, we find the value reduction caused by Knightian uncertainty is much more substantial for the value of growth opportunities. Finally, the implications of the user cost of capital and stationary distribution of firm value are also examined.

Keywords: Capacity choice; Knightian uncertainty; Assets in place; Growth opportunities (search for similar items in EconPapers)
JEL-codes: D81 E22 G31 (search for similar items in EconPapers)
Date: 2019
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Handle: RePEc:eee:ecolet:v:174:y:2019:i:c:p:189-194