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Understanding Investment Irreversibility In General Equilibrium

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  • Miquel Faig

Abstract

This paper advances a tractable model designed to understand investment irreversibility in general equilibrium. The tractability of the model allows analytical results which explain the contrast, emphasized in the extant literature (e.g., Coleman [1997]), between the consequences of irreversibility for individual firms and the consequences of irreversibility for the whole economy. In general equilibrium, irreversibility affects both the wealth of consumers and the return on assets. In the model explored, as long as the inter-temporal elasticity of substitution is realistically low (less than one), investment irreversibility not only prevents capital destruction, but it also induces capital creation. Furthermore, under certain conditions, irreversibility raises the risk premium by increasing the variability of both consumption and the market portfolio.

Suggested Citation

  • Miquel Faig, 1998. "Understanding Investment Irreversibility In General Equilibrium," Working Papers faig-98-01, University of Toronto, Department of Economics.
    • Handle: RePEc:tor:tecipa:faig-98-01
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    References listed on IDEAS

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    1. Bertola, Giuseppe, 1994. "Flexibility, investment, and growth," Journal of Monetary Economics, Elsevier, vol. 34(2), pages 215-238, October.
    2. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    3. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-1148, September.
    4. Andrew Caplin & John Leahy, 1993. "Sectoral Shocks, Learning, and Aggregate Fluctuations," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(4), pages 777-794.
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    Cited by:

    1. Miquel Faig, 1999. "Asset Pricing, Growth, And The Business Cycle With Irreversible Investment," Working Papers faig-98-02, University of Toronto, Department of Economics.
    2. Muro, Kazunobu, 2007. "Individual preferences and the effect of uncertainty on irreversible investment," Research in Economics, Elsevier, vol. 61(4), pages 191-207, December.

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    More about this item

    Keywords

    Irreversible Investment; Stochastic Growth; Asset Pricing;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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