Irreversible capital accumulation under interest rate uncertainty |
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Authors: | Luis H R Alvarez |
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Institution: | 1. Department of Accounting and Finance, Turku School of Economics, Turku, 20500, Finland
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Abstract: | We consider the optimal sequential irreversible investment policy of a value maximizing firm facing decreasing returns to
scale and interest rate uncertainty. We characterize the optimal accumulation policy and its value for a broad class of diffusion
models of the short interest rate by focusing on the marginal investment decision and deriving the marginal value of capital
explicitly. We also state a set of conditions under which there is a maximal capital stock above which the option to expand
productive capacity further in the future becomes valueless. Hence, our results indicate that interest rate uncertainty may
limit the size of an optimally investing firm. |
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Keywords: | |
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