NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Options, the Value of Capital, and Investment

Andrew B. Abel, Avinash K. Dixit, Janice C. Eberly, Robert S. Pindyck

NBER Working Paper No. 5227 (Also Reprint No. r2087)
Issued in August 1995
NBER Program(s):   AP   EFG   IO   PR

Capital investment decisions must recognize the limitations on the firm's ability later to sell off or expand capacity. This paper shows how opportunities for future expansion or contraction can be valued as options, how this valuation relates to the q-theory of investment, and how these options affect the incentive to invest. Generally, the option to expand reduces the incentive to invest, while the option to disinvest raises it. We show how these options interact to determine the effect of uncertainty on investment, how these option values change in response to shifts of the distribution of future profitability, and how the q-theory and option pricing approaches to investment are related.

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Document Object Identifier (DOI): 10.3386/w5227

Published: Quarterly Journal of Economics, vol. 111, no. 3, pp. 753-777, August 1996.

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