Optimal Diversity in Investments with Recombinant Innovation

Tinbergen Institute Discussion Paper No. 08-091/1

34 Pages Posted: 26 Sep 2008

See all articles by Jeroen C. J. M. van den Bergh

Jeroen C. J. M. van den Bergh

VU University Amsterdam - Department of Spatial Economics

Paolo Zeppini-Rossi

University of Amsterdam - CeNDEF

Date Written: September 26, 2008

Abstract

We address the notion of dynamic, endogenous diversity and its role in theories of investment and technological innovation. We develop a formal model of an innovation arising from the combination of two existing modules with the objective to optimize the net benefits of diversity. The model takes into account increasing returns to scale and the effect of different dimensions of diversity on the probability of emergence of a third option. We obtain analytical solutions describing the dynamic behaviour of the values of the options. Next we optimize diversity by trading off the benefits of diversity (due to recombinant innovation) and the benefits associated with returns to scale. We derive conditions for optimal diversity under different regimes of returns to scale. When the investment time horizon is beyond a threshold value, the best choice becomes diversity. This threshold will be larger the higher the returns to scale.

Keywords: balance, diversity, increasing returns, recombinant innovation, scale effects

JEL Classification: B52, C61, O31, Q55

Suggested Citation

van den Bergh, Jeroen C.J.M. and Zeppini-Rossi, Paolo, Optimal Diversity in Investments with Recombinant Innovation (September 26, 2008). Tinbergen Institute Discussion Paper No. 08-091/1. Available at SSRN: https://ssrn.com/abstract=1274093 or http://dx.doi.org/10.2139/ssrn.1274093

Jeroen C.J.M. Van den Bergh (Contact Author)

VU University Amsterdam - Department of Spatial Economics ( email )

De Boelelaan 1105
Faculty of Economics and Econometrics
1081HV Amsterdam
Netherlands

Paolo Zeppini-Rossi

University of Amsterdam - CeNDEF ( email )

Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands

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