An Equilibrium Model of Investment under Uncertainty

Posted: 25 Jun 2008

See all articles by Robert Novy-Marx

Robert Novy-Marx

Simon Business School, University of Rochester; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: 2007

Abstract

We analyze the optimal investment decisions of heterogeneous firms in a competitive, uncertain environment, characterizing firms' investment strategies explicitly and deriving closed-form solutions for firm value. Real option premia remain significant, and are even unmitigated relative to the standard partial-equilibrium model when both are calibrated to observables. Firms consequently delay investment, choosing not to undertake some positive NPV projects. We compare competitive behavior to that of a strategic monopolist, and quantify the welfare loss associated with monopoly. Finally, the model predicts business cycle dependence on firm returns, with returns negatively skewed during industry expansions but positively skewed in industry recessions.

Keywords: G12, E22, R14

Suggested Citation

Novy-Marx, Robert, An Equilibrium Model of Investment under Uncertainty (2007). The Review of Financial Studies, Vol. 20, Issue 5, pp. 1461-1502, 2007, Available at SSRN: https://ssrn.com/abstract=1151163 or http://dx.doi.org/10.1093/rfs/hhm013

Robert Novy-Marx (Contact Author)

Simon Business School, University of Rochester ( email )

Rochester, NY 14627
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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