Pursuing the Wrong Options? Adjustment Costs and the Relationship between Uncertainty and Capital Accumulation

Abstract

Abel and Eberly (1999) show that the effect of uncertainty on long run capital accumulation is ambiguous in a real options model with irreversible investment. We show that a higher level of uncertainty tends to reduce expected capital stock levels in a model with strictly convex adjustment costs. Simulations suggest that this negative impact of uncertainty on cap- ital accumulation may be substantial. We also provide some intuition for this result.