Investment options and the business cycle

Boyan Jovanovic

    Research output: Contribution to journalArticle

    Abstract

    This paper extends [R. Mehra, E.C. Prescott, Recursive competitive equilibrium: The case of homogeneous households, Econometrica 48 (1980) 1365-1380] 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 from the adjustment-cost model. Equilibrium may be efficient even without markets for knowledge; the stock market may suffice.

    Original languageEnglish (US)
    Pages (from-to)2247-2265
    Number of pages19
    JournalJournal of Economic Theory
    Volume144
    Issue number6
    DOIs
    StatePublished - Nov 1 2009

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    Keywords

    • Adjustment costs
    • Intertemporal substitution
    • Tobin's Q

    ASJC Scopus subject areas

    • Economics and Econometrics

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