An investment theory with lags and adjustment costs

40 Pages Posted: 29 Mar 2022

See all articles by Wei Jiang

Wei Jiang

Hong Kong University of Science and Technology

Shuaijie Qian

Center of Mathematical Sciences and Applications, Harvard University

Jialu Shen

University of Missouri at Columbia - Department of Finance

Date Written: March 5, 2022

Abstract

We propose a stochastic control model to study corporate investment with generalized investment frictions, including investment lags and various of adjustment costs. We find that the dominance of the ``good news principle'' or ``bad news principle'' is determined by the joint effect of investment lags and adjustment costs, reconciling the results in Bernanke (1983) and Bar-Ilan and Strange (1996). Meanwhile, we resolve disputes between the net present value rule and the real option method of making investment decisions, and we find that the accuracy of the NPV rule depends on both investment lags and the opportunity cost of adjustment. Moreover, we calibrate our model with aggregated firm data and show that the co-existence of investment lags and the opportunity cost of adjustment is the key to explaining the correlation between investment and lagged profit.

Keywords: Bad News Principle, Investment Lags, Adjustment Costs, NPV Method, Real Option

JEL Classification: D21, E22, E32

Suggested Citation

Jiang, Wei and Qian, Shuaijie and Shen, Jialu, An investment theory with lags and adjustment costs (March 5, 2022). Available at SSRN: https://ssrn.com/abstract=4050648 or http://dx.doi.org/10.2139/ssrn.4050648

Wei Jiang (Contact Author)

Hong Kong University of Science and Technology ( email )

Clear water bay
Kowloon
Hong Kong
China

Shuaijie Qian

Center of Mathematical Sciences and Applications, Harvard University ( email )

20 Garden Street
Cambridge, MA 02138
United States

Jialu Shen

University of Missouri at Columbia - Department of Finance ( email )

Columbia, MO 65211
United States

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