Investment Options and the Business Cycle
This paper extends Lucas (1978) to a production economy with two capital goods. It is an RBC model in which each unit of investment requires a new idea, an "option". When options are scarce, new capital is harder to put in place and the value of old capital rises. Thus the stock market and Tobin's Q are negative indexes of intangibles. During a boom, Q rises gradually, as options are used up. Because investment represents an exercise of options, it has an intertemporal substitution tradeoff that is absent in the adjustment-cost model. Equilibrium may be efficient even without markets for knowledge; the stock market may suffice.
I thank J. Campbell, J. Eaton, R. Gordon, B. Hall, R. Hall, H. Hopenhayn, A. Kurmann, and N. Stokey for comments, V. Tsyrennikov for computations, corrections, comments, and for writing Appendix 1, and the NSF for support. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Jovanovic, Boyan, 2009. "Investment options and the business cycle," Journal of Economic Theory, Elsevier, vol. 144(6), pages 2247-2265, November. citation courtesy of