Fixed Investment and Capital Flows: A Real Options Approach

28 Pages Posted: 15 Feb 2006

See all articles by Jorge A. Chan-Lau

Jorge A. Chan-Lau

International Monetary Fund (IMF) - International Capital Markets Department

Peter B. Clark

International Monetary Fund (IMF)

Date Written: August 1998

Abstract

This paper draws a link between international capital flows and the real options approach to investment by extending a model of real estate investment. It explains gradual investment, investment booms, and investment during recessions and emphasizes sunk costs, uncertainty, and the value of waiting. The optimal waiting time increases as foreign borrowing becomes more expensive because higher returns are required to cover the sunk costs of investing. The lower the initial level of profitability, the more likely investment will be sequential; conversely, a relatively high initial rate of return will be associated with simultaneous investment.

Keywords: capital flows, irreversible investment, interest rate spread, strategic behavior

JEL Classification: F21, F32

Suggested Citation

Chan-Lau, Jorge Antonio and Clark, Peter B., Fixed Investment and Capital Flows: A Real Options Approach (August 1998). Available at SSRN: https://ssrn.com/abstract=882674 or http://dx.doi.org/10.2139/ssrn.882674

Jorge Antonio Chan-Lau (Contact Author)

International Monetary Fund (IMF) - International Capital Markets Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Peter B. Clark

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

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