Fixed Investment and Capital Flows: A Real Options Approach

Jorge Chan-Lau and Peter Clark

No 1998/125, IMF Working Papers from International Monetary Fund

Abstract: This paper draws a link between international capital flows and the real options approach to investment by extending a model of real estate investment. It explains gradual investment, investment booms, and investment during recessions and emphasizes sunk costs, uncertainty, and the value of waiting. The optimal waiting time increases as foreign borrowing becomes more expensive because higher returns are required to cover the sunk costs of investing. The lower the initial level of profitability, the more likely investment will be sequential; conversely, a relatively high initial rate of return will be associated with simultaneous investment.

Keywords: WP; interest rate; present discounted value; capital stock; borrowing cost; rate of return; capital flows; irreversible investment; interest rate spread; strategic behavior; investment activity; investment boom; investment decision; cost of capital; Stocks; Competition; Foreign direct investment; Emerging and frontier financial markets; Asia and Pacific (search for similar items in EconPapers)
Pages: 28
Date: 1998-08-01
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Journal Article: Fixed Investments and Capital Flows: A Real Options Approach (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:imf:imfwpa:1998/125

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