The Irreversibility Premium

54 Pages Posted: 27 Mar 2008

See all articles by Robert S. Chirinko

Robert S. Chirinko

University of Illinois at Chicago, Department of Finance; CESifo (Center for Economic Studies and Ifo Institute)

Huntley Schaller

Carleton University - Department of Economics

Date Written: March 2008

Abstract

When investment is irreversible, theory suggests that firms will be "reluctant to invest." This reluctance creates a wedge between the discount rate guiding investment decisions and the standard Jorgensonian user cost (adjusted for risk). We use the intertemporal tradeoff between the benefits and costs of changing the capital stock to estimate this wedge, which we label the irreversibility premium. Estimates are based on panel data for the period 1980-2001. The large dataset allows us to estimate the effects of limited resale markets, low depreciation rates, high uncertainty, and negative industry-wide shocks on the irreversibility premium. Our estimates provide a readily interpretable measure of the importance of irreversibility and document that the irreversibility premium is both economically and statistically significant.

Keywords: irreversibility, investment, non-convex adjustment costs

JEL Classification: E22, E32

Suggested Citation

Chirinko, Robert S. and Schaller, Huntley, The Irreversibility Premium (March 2008). CESifo Working Paper Series No. 2265. Available at SSRN: https://ssrn.com/abstract=1113265

Robert S. Chirinko (Contact Author)

University of Illinois at Chicago, Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States

HOME PAGE: http://tigger.uic.edu/~chirinko/

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Huntley Schaller

Carleton University - Department of Economics ( email )

1125 Colonel By Drive
Ottawa, Ontario K1S 5B6
Canada
613-520-3751 (Phone)
613-520-3906 (Fax)

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