Weeds, Helen (1999) 'Reverse hysteresis': R&D investment with stochastic innovation. Working Paper. University of Warwick, Department of Economics, Coventry.

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Abstract

We consider optimal investment behavior for a firm facing both technological and economic uncertainty, in the context of a research project with unpredictable outcomes. The optimal investment strategy, in the form of a pair of trigger points for investment and abandonment, is derived. As in Dixit (1989), the investment trigger exceeds the Marshallian investment point. However the abandonment trigger may exceed the Marshallian exit point, in contrast to the Dixit result, giving rise to ‘reverse hysteresis.’ Thus the firm tends to abandon research rapidly as profitability declines, at times despite the existence of positive expected profits. The model also provides a unified framework encompassing two existing models as limiting cases.

Item Type:	Working or Discussion Paper (Working Paper)
Alternative Title:	'Reverse hysteresis': research and development investment with stochastic innovation
Subjects:	H Social Sciences > HB Economic Theory
Library of Congress Subject Headings (LCSH):	Hysteresis (Economics), Research and development projects, Investment analysis, Uncertainty, Technological innovations -- Economic aspects
Series Name:	Warwick economic research papers
Publisher:	University of Warwick, Department of Economics
Place of Publication:	Coventry
Date:	16 May 1999
Number:	No.578
Number of Pages:	23
Status:	Not Peer Reviewed
Access rights to Published version:	Open Access
Funder:	Economic and Social Research Council (Great Britain) (ESRC), Merton College
Grant number:	R00429524353 (ESRC)
References:	BAR-ILAN, Avner, and William C. STRANGE (1998), “A model of sequential investment,” Journal of Economic Dynamics and Control, 22, 437-463. DASGUPTA, Partha, and Joseph STIGLITZ (1980), “Uncertainty, industrial structure and the speed of R&D,” Bell Journal of Economics, 11 (autumn), 1-28. DIXIT, Avinash K. (1988), “A general model of R&D competition and policy,” RAND Journal of Economics, 19 (autumn), 317-326. —— (1989), “Entry and exit decisions under uncertainty,” Journal of Political Economy, 97 (June), 620-638. —— and Robert S. PINDYCK (1994), Investment Under Uncertainty, Princeton University Press. LAMBRECHT, Bart (1998), “Strategic sequential investments and sleeping patents,” in M. J. Brennan and L. Trigeorgis (eds.), Innovation, Infrastructure and Strategic Options, Oxford University Press, forthcoming. LEE, Tom, and Louis L. WILDE (1980), “Market structure and innovation: A reformulation,” Quarterly Journal of Economics, 94, 429-436. LOURY, Glenn C. (1979), “Market structure and innovation,” Quarterly Journal of Economics, 93, 395-410. MAJD, Saman, and Robert S. PINDYCK (1987), “Time to build, option value, and investment decisions,” Journal of Financial Economics, 18, 7-27. McDONALD, Robert, and Daniel SIEGEL (1986), “The value of waiting to invest,” Quarterly Journal of Economics, 101 (November), 707-728. PINDYCK, Robert S. (1993), “Investments of uncertain cost,” Journal of Financial Economics, 34, 53-76. REINGANUM, Jennifer (1983), “Uncertain innovation and the persistence of monopoly,” American Economic Review, 73 (September), 741-748.
URI:	http://wrap.warwick.ac.uk/id/eprint/1600

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