Investment Options and the Business Cycle

Abstract

This paper extends Lucas (1978) to a production economy with two capital goods. It is an RBC model in which each unit of investment requires a new idea, an "option". When options are scarce, new capital is harder to put in place and the value of old capital rises. Thus the stock market and Tobin's Q are negative indexes of intangibles. During a boom, Q rises gradually, as options are used up. Because investment represents an exercise of options, it has an intertemporal substitution tradeoff that is absent in the adjustment-cost model. Equilibrium may be efficient even without markets for knowledge; the stock market may suffice. Lucas (1978) to a production economy with two capital goods. It is an RBC model in which each unit of investment requires a new idea, an "option". When options are scarce, new capital is harder to put in place and the value of old capital rises. Thus the stock market and Tobin's Q are negative indexes of intangibles. During a boom, Q rises gradually, as options are used up. Because investment represents an exercise of options, it has an intertemporal substitution tradeoff that is absent in the adjustment-cost model. Equilibrium may be efficient even without markets for knowledge; the stock market may suffice.

Wait-and-see: Investment options under policy uncertainty

“…Jovanovic (2009) studies an RBC model with "investment options" that are similar to the projects here, and an aggregate TFP shock of the standard type. Periods with high realizations for the TFP shock produce investment booms, as in the standard RBC model.…”

“…Projects can be thought of as specific investment opportunities, as in McDonald and Siegel (1986) and Jovanovic (2009). For a retail chain or a service provider, projects might be cities or locations where new outlets could be built.…”

Macroeconomic Models for Monetary Policy: A Critical Review from a Finance Perspective

“…The second method is to model two capital goods: traditional capital called "trees", and investment options called "seeds" (see, e.g. Jovanovic, 2009). In a high uncertainty environment, the investment in seeds experiences a gradual boom.…”

The co-evolution of Saldanha Bay (town and hinterland) and its Port

“…It focuses on the path-dependent dynamics underlying uneven development in space Sunley, 2006, 2011). This approach has contributed significantly to the enrichment of economic geography, adding new perspectives to the long-term process of structural change over space and in time (Brouder, 2014;Jovanovic, 2009). EEG studies the origin, changes, direction and speed in the spatial distribution and organisation of production, as well as consumption, over time.…”