Optimal Investment under Price and Wage Uncertainty

Abstract

The effects of future output price uncertainty and wage uncertainty on a firm's investment decision are examined in this paper, by assuming the competitively risk-neutral firm maximizes the expected value of the sum of discounted cash flows. We find that the optimal investment behavior is such that the expected proportional growth rate of investment is invariant over time, although there exists a tradeoff between the effects of the two uncertainty on firm's investment because the shift in output price has positive effects on firm's investment, whereas the shift in wage has negative impacts on firm's investment. And what's more important, fluctuations in output price and wage are correlated so that changes in output price tend to be accompanied by changes in wage.