Assessing Capital Investment Strategy under Ambiguity
The uncertainty of the business environment is increasing more and more. Firms’ managers face complex business environments and the diﬃculty of predicting likely future outcomes. How they treat uncertainty is important in business decision making, such as investing in capital stock. In this paper, we consider a ﬁrm’s investment problem under uncertainty. In particular, we focus on a certain type of uncertainty to incorporate the unpredictable business environment. We consider the ﬁrm’s investment problem under ambiguity, which is also termed Knightian uncertainty. The probability of an outcome is not uniquely determined under ambiguity or Knightian uncertainty (Knight, 1921).
Suppose that a ﬁrm produces a single output and sells it in a market. The ﬁrm’s problem is to decide the production capital investment rate to maximize its proﬁt as in Abel and Eberly (1997). Investing in the capital requires a quadratic-type adjustment cost in addition to the purchase price, which is assumed to be constant. In this paper, we consider the case in which the ﬁrm’s manager cannot predict the future price of the output precisely. To be more precise, he cannot uniquely identify the probability distribution of the output price. Then, he has to determine the investment strategy under output price ambiguity. In Abel and Eberly (1997), the ﬁrm’s manager can uniquely identify the distribution of the output price. This paper is an extension of the research of Abel and Eberly (1997) by incorporating ambiguity. In order to reﬂect the misspeciﬁcation of the model, we use robust control techniques developed by Hansen and Sargent (2001), Hansen et al. (2002), and Hansenet al. (2006). These techniques are based on the multiple priors framework by Gilboa and Schmeidler (1989). We formulate the ﬁrm’s problem as a robust control problem and show that the equation derives the optimal investment strategy. This research is based on joint work with Junich Imai.
About the speaker
Motoh Tsujimura is Associate Professor of Operations Research in the Faculty of Commerce, Doshisha University, Japan. His research interests include real options, environmental policy under uncertainty, natural resource management problems under uncertainty and payout policy. Motoh Tsujimura has a PhD in Economics from Osaka University.
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