Investment Under Uncertainty and Policy Change

29 Pages Posted: 28 May 2001

See all articles by Grzegorz Pawlina

Grzegorz Pawlina

Lancaster University - Department of Accounting and Finance

Peter M. Kort

Tilburg University - Department of Econometrics & Operations Research; Tilburg University - Center for Economic Research (CentER)

Date Written: March 2002

Abstract

In this paper the impact of policy change on the investment behavior of the firm is studied. The change occurs when a stochastic process describing the state of the economic environment reaches a certain trigger. In our setting both the firm's conjecture concerning the trigger as well as the precision of this conjecture serve as input parameters. We derive the optimal investment rule maximizing the value of the firm. We show that the impact of trigger value uncertainty is non-monotonic: the investment threshold decreases with the trigger value uncertainty for low levels of uncertainty, while the reverse is true for high uncertainty levels. Furthermore, it is shown that the uncertainty concerning the magnitude of the change delays investment. Finally, based on the firm's value-maximizing behavior, policy implications for the authority are presented.

Keywords: investment under uncertainty, real options, policy change

JEL Classification: C61, D81, G31

Suggested Citation

Pawlina, Grzegorz and Kort, Peter, Investment Under Uncertainty and Policy Change (March 2002). Available at SSRN: https://ssrn.com/abstract=271077 or http://dx.doi.org/10.2139/ssrn.271077

Grzegorz Pawlina (Contact Author)

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom
+ 44 1524 592834 (Phone)
+ 44 1524 847321 (Fax)

Peter Kort

Tilburg University - Department of Econometrics & Operations Research ( email )

Tilburg, 5000 LE
Netherlands
+31 13 466 2062 (Phone)
+31 13 466 3072 (Fax)

HOME PAGE: http://center.uvt.nl/staff/kort/

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2062 (Phone)
+31 13 466 3072 (Fax)