The Hedging Effect of Low Durability Capital Assets in Competitive Industries

79 Pages Posted: 17 Sep 2019 Last revised: 20 Jan 2023

See all articles by Thomas Dangl

Thomas Dangl

Vienna University of Technology

Hamed Ghoddusi

California State Polytechnic University, San Luis Obispo; Economic Research Forum

Sebastian Rötzer

University of Lausanne - Institute of Banking and Finance (IBF); Swiss Finance Institute, Students

Date Written: September 30, 2022

Abstract

We highlight the impact of physical capital durability on firms' investment behavior, output price dynamics, and industry equilibrium outcomes. In particular, we identify industry-wide depreciation of capital assets as a hedge against long-lasting episodes of overcapacity, and document that the equilibrium firm value might be negatively associated with capital durability. In particular, low demand elasticity increases the hedging effect of capital depreciation. In a dynamic model of equilibrium investment under uncertainty we develop endogenous output-price dynamics and closed-form solutions for optimal investment policies, firm value, as well as for the steady-state distribution of output prices. From this model we derive a set of testable predictions on expected equilibrium output prices, entry dynamics and the above mentioned hedging effect of low capital durability. We document broad empirical support for these predictions in a large sample of U.S. manufacturing firms.

Keywords: Capacity Options, Durability of Capital, Dynamic Investment under Uncertainty, Depreciation, Rational Expectations Equilibrium

JEL Classification: E2, E22, D25

Suggested Citation

Dangl, Thomas and Ghoddusi, Hamed and Rötzer, Sebastian, The Hedging Effect of Low Durability Capital Assets in Competitive Industries (September 30, 2022). Available at SSRN: https://ssrn.com/abstract=3449915 or http://dx.doi.org/10.2139/ssrn.3449915

Thomas Dangl (Contact Author)

Vienna University of Technology ( email )

Theresianumgasse 27
Vienna, A-1040
Austria

Hamed Ghoddusi

California State Polytechnic University, San Luis Obispo ( email )

San Luis Obispo, CA 93407
United States

Economic Research Forum ( email )

Cairo
Egypt

Sebastian Rötzer

University of Lausanne - Institute of Banking and Finance (IBF) ( email )

CH-1015 Lausanne
Switzerland

Swiss Finance Institute, Students ( email )

c/o University of Geneva
42, Bd du Pont d'Arve
Geneva, CH-1211
Switzerland

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
197
Abstract Views
1,033
Rank
231,552
PlumX Metrics