Finance Papers

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Journal Article

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The American Economic Review





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price uncertainty on the investment decision of a risk-neutral competitive firm which faces convex costs of adjustment.' This issue has been analyzed by Richard Hartman (1972) and by Robert Pindyck (1982), but they reached dramatically different results. Hart- man showed that with a linearly homogeneous production function, increased output price uncertainty leads the competitive firm to increase its investment. However, Pindyck found increased output price uncertainty leads to increased investment only if the marginal adjustment cost function is convex; but, if the marginal adjustment cost function is concave, then increased uncertainty will reduce the rate of investment. Pindyck argues that his results differ from Hartman's results because of a different stochastic specification of the price of output. In Hartman's discretetime model, price is random in each period including the current period, whereas in Pindyck's continuous-time model, the cur- rent price is known but the future evolution of prices is stochastic. In this paper, I demonstrate that Hartman's results continue to hold using Pindyck's stochastic specification and that Pindyck's analysis applies to a so- called "target" rate of investment, which in general is not optimal.

Copyright/Permission Statement

Copyright © 1983 by the American Economic Association.full citation, including the name of the author. Abel, Andrew B. "Optimal Investment Under Uncertainty." The American Economic Review 73, no. 1 (1983): 228-33.



Date Posted: 27 November 2017

This document has been peer reviewed.