Investment in High-Tech Industries: An Example from the LCD Industry

CentER Discussion Paper Series No. 2007-85

26 Pages Posted: 4 Nov 2007

See all articles by Kuno Huisman

Kuno Huisman

Tilburg University, CentER; ASML

Peter M. Kort

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

Joseph Plasmans

University of Antwerp - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); Tilburg University

Date Written: October 2007

Abstract

This paper considers a representative firm taking investment decisions in a high-tech environment where different generations of products are invented over time. First, we develop a real options investment model in which, according to standard practice, the sales price and the unit production cost both satisfy a geometric Brownian motion (GBM) process. However, from real life data of the LCD industry it follows that output prices behave according to a crystal cycle that does not match a GBM. We proceed by conducting a thorough econometric analysis, leading to the conclusion that a vector autoregressive model (VAR) provides the best fit. Integrating this model with the real options machinery, we find that (i) at the moment of investment the increased production capacity goes along with increasing production cost and decreasing price, (ii) a management effect is present in the sense that a price drop is followed by a cost decrease due to management pushing harder on cost decreasing programs, and (iii) investing can be optimal while at the same time a GBM yields a negative net present value (NPV). We also find that investment decisions taken in practice are better supported by our V AR model than by the standard real options model based on GBM.

Keywords: High-tech Investment, Investment under Uncertainty, Product Innovation, Real Options, Vector Autoregressive Model

JEL Classification: C32, D92, E22, O33

Suggested Citation

Huisman, Kuno J.M. and Kort, Peter and Plasmans, Joseph E. J., Investment in High-Tech Industries: An Example from the LCD Industry (October 2007). CentER Discussion Paper Series No. 2007-85, Available at SSRN: https://ssrn.com/abstract=1026609 or http://dx.doi.org/10.2139/ssrn.1026609

Kuno J.M. Huisman (Contact Author)

Tilburg University, CentER ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

ASML ( email )

De Run 6501
Veldhoven, 5504 DR
Netherlands

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)

Joseph E. J. Plasmans

University of Antwerp - Department of Economics ( email )

Prinsstraat 13
Antwerp, B-2000
Belgium

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Tilburg University

Postbus 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

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