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Investment, irreversibility, and options: An empirical framework

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  • Joseph Shaanan
Abstract
The paper presents an empirical test of the impact of irreversibility on threshold return levels and on investment. These tests permit an examination of a key concept and some predictions of irreversible investment theory, which links the option pricing approach with Tobin's q theory. A key feature of the paper is that estimates of the threshold return levels required for investment, which account for both options to invest and disinvest, are obtained internally from the empirical model. The study employs a panel data set consisting of U.S. manufacturing firms and finds that irreversibility, through its negative impact on marginal put options and the resulting increase in threshold returns, reduces investment in two of the four groups of firms studied.

Suggested Citation

  • Joseph Shaanan, 2005. "Investment, irreversibility, and options: An empirical framework," Review of Financial Economics, John Wiley & Sons, vol. 14(3-4), pages 241-254.
    • Handle: RePEc:wly:revfec:v:14:y:2005:i:3-4:p:241-254
    DOI: 10.1016/j.rfe.2004.11.001
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    References listed on IDEAS

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