On the Uncertainty-Investment Relationship: An Overview with an Application to the Power Plant Investments in Turkish Electricity Sector

Title:

On the Uncertainty-Investment Relationship: An Overview with an Application to the Power Plant Investments in Turkish Electricity Sector

Number:

14/39

Author(s):

Erdal YILMAZ

Language:

English

Date:

November 2014

Abstract:

The effect of uncertainty on investment is widely considered to have a negative sign in the real option literature. Contrary to prediction of conventional real option theory, there are studies pioneered by Sarkar (2000) and Gryglewicz et al. (2008) with the argument that this negative relationship is not always correct. Such result is exceptional, since they show that uncertainty may accelerate irreversible investment without building on the convexity of the marginal product of capital in the real option framework. Major contribution of this paper, by applying the Gryglewicz et al. (2008) approach, is to show numerically that the uncertainty-investment relationship in Turkish electricity plant investment is non-monotonic and U-shaped. We also numerically compare those two studies and investigate whether certain conditions in Sarkar (2000) are associated with the parameter support by Gryglewicz et al. (2008) or not. Finally, we numerically demonstrate partial effect of the interest rate changes on optimal investment trigger based on Gryglewicz et al. (2008) framework.

Keywords:

Investment, Real option, Uncertainty.

JEL Codes:

D92, E22, G31