Extension and Empirical Application of the Theory Investment Under Uncertainty

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This project has two objectives: (1) to develop a theoretical framework that integrates and extends existing models of capital investment; and (2) to apply this framework to data on capital investment by firms and by industries. The theoretical framework emphasizes the costs of adjusting the size of the capital stock and includes the facts that firms may pay a higher price for capital when they buy than when they sell capital, that it may cost more per unit to adjust the capital stock quickly rather than slowly, and that adjusting the capital stock may involve fixed costs. Rather than explore the role of a single adjustment technology in isolation, this model specification allows the nesting of possible adjustment costs, resale market imperfections, and acquisition costs, while further allowing for fixed adjustment costs and irreversible investment. Also, the resulting investment function is simple enough to admit direct empirical examination, and the tractability of aggregation problems allows estimation in both firm-level and industry level data. This research is important because it holds the prospect of making an important break through in better understanding the investment behavior of firms and industries.