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Macroeconomic conditions and a firm's investment decisions

Michi Nishihara
2014
Journal paper
Abstract

We propose a model of a firm's reversible investment decision with macroeconomic conditions based on optimal switching of a diffusion regime. The switching costs and the cash flow generated from the firm depend on a business cycle alternating via a Markov chain, and the triggers of investment and disinvestment in each state are determined endogenously. Provided the investment costs are cyclical due to high wages and rents in a boom, the investment tends to be delayed in boom, while the disinvestment is likely to be made earlier in terms of the level of switching triggers. This result shows us that the 'hysteresis' of investment is a rigorous phenomenon that does not change dramatically depending on business cycle. Yet, the business cycle may still amplify and propagate the exogenous shocks from macroeconomic conditions as far as the persistence of business cycle is concerned. In particular, the investment is deferred and the disinvestment occurs earlier when recession lasts longer and boom ends soon. (C) 2014 Elsevier Inc. All rights reserved.

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Ontological neighbourhood
Economics
Business
Related concepts (35)
Investment fund
An investment fund is a way of investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group such as reducing the risks of the investment by a significant percentage. These advantages include an ability to: hire professional investment managers, who may offer better returns and more adequate risk management; benefit from economies of scale, i.e., lower transaction costs; increase the asset diversification to reduce some unsystematic risk.
Business cycle
Business cycles are intervals of expansion followed by recession in economic activity. A recession is sometimes technically defined as 2 quarters of negative GDP growth, but definitions vary; for example, in the United States, a recession is defined as "a significant decline in economic activity spread across the market, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.
Macroeconomics
Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole—for example, using interest rates, taxes, and government spending to regulate an economy's growth and stability. This includes regional, national, and global economies. Macroeconomists study topics such as GDP (Gross Domestic Product), unemployment (including unemployment rates), national income, price indices, output, consumption, inflation, saving, investment, energy, international trade, and international finance.
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