The Irreversibility Premium
54 Pages Posted: 27 Mar 2008
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: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Uncertainty and Investment Dynamics
By Nicholas Bloom, Stephen R. Bond, ...
-
The Differential Impact of Uncertainty on Investment in Small and Large Businesses
By Vivek Ghosal and Prakash Loungani
-
Uncertainty and Economic Activity: Evidence from Business Survey Data
By Ruediger Bachmann, Steffen Elstner, ...
-
Exploring the Role of Uncertainty for Corporate Investment Decisions in Germany
-
Uncertainty and Company Investment Dynamics: Empirical Evidence for UK Firms
By Nicholas Bloom, Stephen R. Bond, ...
-
Does Demand and Price Uncertainty Affect Belgian and Spanish Corporate Investment?
-
The Impact of Uncertainty on Investment Plans
By Paul Butzen, Catherine Fuss, ...
-
Firm-Specific Productivity Risk Over the Business Cycle: Facts and Aggregate Implications
By Ruediger Bachmann and Christian Bayer
-
Firms' Investment Decisions in Response to Demand and Price Uncertainty
By Catherine Fuss and Philip Vermeulen