Title: The Effects of Irreversibility on the Timing and Intensity of Lumpy Investment
Reference Number: 1196
Publication Date: September 2009
JEL Classifcation: D21, D81, G31

Kit Pong Wong
The University of Hong Kong

This paper examines how changes in irreversibility of investment affect the timing and intensity of lumpy investment. We develop a continuous-time model wherein a firm is endowed with a perpetual option to invest in a project at any time by incurring a partially reversible investment cost at that instant. The amount of the investment cost is directly related to the intensity of investment that is endogenously chosen by the firm at the instant when the investment option is exercised. We show that higher irreversibility of investment induces the firm to raise its optimal investment trigger, thereby deferring the undertaking of the project. Furthermore, we show that changes in irreversibility of investment have no impact on the firm's optimal investment intensity due to two opposing effects that exactly offset each other. Finally, we show that higher irreversibility of investment reduces the value of the investment option and, therefore, makes the firm less valuable.

Published in Economic Modelling 27 (January 2010), pp. 97-102.

Key words: Investment intensity, Investment timing, Irreversibility, Real options

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Last modified: 09/15/2010