Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/201700
Authors: 
Deopa, Neha
Rinaldo, Daniele
Year of Publication: 
2019
Series/Report no.: 
Graduate Institute of International and Development Studies Working Paper 04-2019
Abstract: 
We present a model of firm investment under uncertainty and partial irreversibility in which uncertainty is represented by a jump diffusion. This allows to represent both the continuous Gaussian volatility and the discontinuous uncertainty related to information arrival, sudden changes and large shocks. The model shows how both sources of uncertainty negatively impact the optimal investment and disinvestment policies, and how the presence oflarge negative jumps can drastically affect the firm's ability to recover. Our results show that the standard Gaussian framework consistently underestimates the negative effect of uncertainty on firm investment decisions. We test these predictions on a panel dataset of UK firms: we first structurally estimate the uncertainty parameters using multinomial maximum likelihood and differential evolution techniques and subsequently study their impact on firm investment rates, validating our model predictions.
Subjects: 
firm investment
uncertainty
jump diffusions
partial irreversibility
real options
JEL: 
C61
C62
D21
D22
D8
Document Type: 
Working Paper

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