A Unified Model of Investment Under Uncertainty

Andrew Abel and Janice Eberly

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: This paper extends the theory of investment under certainty to incorporate fixed costs of investment, a wedge between the purchase price and sale price of capital, and potential irreversibility of investment. In this extended framework, investment is a non-decreasing function of q, the shadow price of installed capital. The optimal rate of investment is in one of three regimes (positive, zero, or negative gross investment) depending on the value of q relative to two critical values. In general however, the shadow price q is not directly observable, so we present two examples relating q to observable variables.

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Related works:
Journal Article: A Unified Model of Investment under Uncertainty (1994)
Working Paper: A Unified Model of Investment Under Uncertainty (1993)
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