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A model of capacity choice under Knightian uncertainty

Author

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  • Niu, Yingjie
  • Zhou, Lei
  • Zou, Zhentao
Abstract
This paper introduces Knightian uncertainty into the standard model of capacity choice and investigates its impact on the firm’s expansion decision. First, we find Knightian uncertainty reduces both the firm value and marginal value of capital. Under Knightian uncertainty, the firm’s expansion decision is shown to be more conservative. When the firm value is decomposed into the value of assets in place and growth opportunities, we find the value reduction caused by Knightian uncertainty is much more substantial for the value of growth opportunities. Finally, the implications of the user cost of capital and stationary distribution of firm value are also examined.

Suggested Citation

  • Niu, Yingjie & Zhou, Lei & Zou, Zhentao, 2019. "A model of capacity choice under Knightian uncertainty," Economics Letters, Elsevier, vol. 174(C), pages 189-194.
    • Handle: RePEc:eee:ecolet:v:174:y:2019:i:c:p:189-194
    DOI: 10.1016/j.econlet.2018.11.024
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    References listed on IDEAS

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    Cited by:

    1. Hu, Fan & Wu, Yaoyao & Zhou, Lei, 2022. "Irreversible investment and capacity choice with Bayesian learning," The North American Journal of Economics and Finance, Elsevier, vol. 63(C).
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    4. Sarkar, Sudipto, 2021. "The uncertainty-investment relationship with endogenous capacity," Omega, Elsevier, vol. 98(C).
    5. Luo, Deqing & Wu, Xiaoping & Xu, Jiawen & Yan, Jingzhou, 2022. "Robust leverage decision under locked wealth and high-water mark contract," Finance Research Letters, Elsevier, vol. 46(PB).
    6. Delaney, Laura, 2022. "The impact of operational delay on irreversible investment under Knightian uncertainty," Economics Letters, Elsevier, vol. 215(C).

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    More about this item

    Keywords

    Capacity choice; Knightian uncertainty; Assets in place; Growth opportunities;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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