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Options, the Value of Capital, and Investment

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Author Info
Andrew B. Abel
Avinash K. Dixit
Janice C. Eberly
Robert S. Pindyck

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Abstract

Capital investment decisions must recognize the limitations on the firm's ability later to sell off or expand capacity. This paper shows how opportunities for future expansion or contraction can be valued as options, how this valuation relates to the q-theory of investment, and how these options affect the incentive to invest. Generally, the option to expand reduces the incentive to invest, while the option to disinvest raises it. We show how these options interact to determine the effect of uncertainty on investment, how these option values change in response to shifts of the distribution of future profitability, and how the q-theory and option pricing approaches to investment are related.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5227.

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Date of creation: Nov 1996
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Handle: RePEc:nbr:nberwo:5227

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-57, June. [Downloadable!] (restricted)
  2. Mussa, Michael L, 1977. "External and Internal Adjustment Costs and the Theory of Aggregate and Firm Investment," Economica, London School of Economics and Political Science, vol. 44(174), pages 163-78, May. [Downloadable!] (restricted)
  3. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Dixit, Avinash K, 1989. "Hysteresis, Import Penetration, and Exchange Rate Pass-Through," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 205-28, May. [Downloadable!] (restricted)
  5. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-38, June. [Downloadable!] (restricted)
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  6. Bernanke, Ben S, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, MIT Press, vol. 98(1), pages 85-106, February. [Downloadable!] (restricted)
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  7. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
  8. Dixit, Avinash, 1992. "Investment and Hysteresis," Journal of Economic Perspectives, American Economic Association, vol. 6(1), pages 107-32, Winter. [Downloadable!] (restricted)
  9. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Blackwell Publishing, vol. 57(3), pages 381-402, July. [Downloadable!] (restricted)
  10. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-48, September. [Downloadable!] (restricted)
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  11. Abel, Andrew B & Eberly, Janice C, 1994. "A Unified Model of Investment under Uncertainty," American Economic Review, American Economic Association, vol. 84(5), pages 1369-84, December. [Downloadable!] (restricted)
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  12. Bartolini, Leonardo, 1993. "Competitive runs : The case of a ceiling on aggregate investment," European Economic Review, Elsevier, vol. 37(5), pages 921-948, June. [Downloadable!] (restricted)
  13. Leahy, John V, 1993. "Investment in Competitive Equilibrium: The Optimality of Myopic Behavior," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1105-33, November. [Downloadable!] (restricted)
  14. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-24, January. [Downloadable!] (restricted)
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  15. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-85, December. [Downloadable!] (restricted)
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