Timing of investment under technological and revenue related uncertainties
Department of Economics, Helsinki School of Economics
P.O. Box 1210, 00101 Helsinki, Finland
Systems Analysis Laboratory Research Reports E11 March 2003
We consider the effects of technological and revenue related uncertainties on the timing of irreversible investment. The distinction between the two types of uncertainty is first characterized within the optimal stopping framework. Then, a specific model motivated by investment in wind power production is presented. Technological progress is modeled as a Poisson arrival process that reduces the cost of investment, and revenue uncertainty is modeled as a geometric Brownian motion process. We show that in the absence of revenue uncertainty the technological uncertainty does not affect the optimal investment rule. However, when combined with revenue uncertainty, increased technological uncertainty makes investment less attractive relative to waiting.
irreversible investment, technological uncertainty, real options, wind power