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Uncertainty and the trade-off between scale and flexibility in investment

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  • Guthrie, Graeme

Abstract

This paper analyzes the behavior of a firm that chooses both the scale and timing of its investment. Sensitivity analysis shows that greater demand volatility is associated with the firm investing in larger increments, less frequently. This is in contrast to the conventional wisdom, which is that greater volatility leads to investment in smaller increments, more frequently. Overall, the reduced frequency dominates the greater scale, so that the long-run average rate of investment is a decreasing function of demand volatility. The timing and scale of investment are most sensitive to volatility when there are substantial investment economies of scale.

Suggested Citation

  • Guthrie, Graeme, 2012. "Uncertainty and the trade-off between scale and flexibility in investment," Journal of Economic Dynamics and Control, Elsevier, vol. 36(11), pages 1718-1728.
    • Handle: RePEc:eee:dyncon:v:36:y:2012:i:11:p:1718-1728
    DOI: 10.1016/j.jedc.2012.04.008
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    References listed on IDEAS

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    17. repec:bla:jecsur:v:14:y:2000:i:2:p:119-53 is not listed on IDEAS
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    Citations

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    Cited by:

    1. Kuno J.M. Huisman & Peter M. Kort, 2015. "Strategic capacity investment under uncertainty," RAND Journal of Economics, RAND Corporation, vol. 46(2), pages 376-408, June.
    2. Liu, Yu-Hong & Jiang, I-Ming, 2019. "Optimal proportion decision-making for two stages investment," The North American Journal of Economics and Finance, Elsevier, vol. 48(C), pages 776-785.
    3. repec:spo:wpmain:info:hdl:2441/6m2bi4eoh48hnr5ile6iol143v is not listed on IDEAS
    4. Guthrie, Graeme, 2013. "A value premium without operating leverage," Finance Research Letters, Elsevier, vol. 10(1), pages 1-11.
    5. Guthrie, Graeme, 2020. "Investment flexibility as a barrier to entry," Journal of Economic Dynamics and Control, Elsevier, vol. 116(C).
    6. Mike Ludkovski, 2022. "Regression Monte Carlo for Impulse Control," Papers 2203.06539, arXiv.org.
    7. repec:hal:spmain:info:hdl:2441/6m2bi4eoh48hnr5ile6iol143v is not listed on IDEAS
    8. Flor, Christian Riis & Hesel, Søren, 2015. "Uncertain dynamics, correlation effects, and robust investment decisions," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 278-298.
    9. G. Guthrie, 2021. "Adapting to Rising Sea Levels: How Short-Term Responses Complement Long-Term Investment," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 78(4), pages 635-668, April.
    10. Ye, Fanglin & Paulson, Nicholas & Khanna, Madhu, 2024. "Strategic innovation and technology adoption under technological uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 165(C).
    11. Guthrie, Graeme, 2020. "Regulation, welfare, and the risk of asset stranding," The Quarterly Review of Economics and Finance, Elsevier, vol. 78(C), pages 273-287.

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    More about this item

    Keywords

    Investment; Uncertainty; Real options; Economies of scale;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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