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A model for the long-term optimal capacity level of an investment project

Lokka, A. and Zervos, Mihail (2011) A model for the long-term optimal capacity level of an investment project. International Journal of Theoretical and Applied Finance, 14 (02). p. 187. ISSN 0219-0249

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Abstract

We consider an investment project that produces a single commodity. The project’s operation yields payoff at a rate that depends on the project’s installed capacity level and on an underlying economic indicator such as the output commodity’s price or demand, which we model by an ergodic, one-dimensional Itˆo diffusion. The project’s capacity level can be increased dynamically over time. The objective is to determine a capacity expansion strategy that maximizes the ergodic or long-term average payoff resulting from the project’s management. We prove that it is optimal to increase the project’s capacity level to a certain value and then take no further actions. The optimal capacity level depends on both the long-term average and the volatility of the underlying diffusion.

Item Type: Article
Official URL: http://www.worldscinet.com/ijtaf/
Additional Information: © 2011 World Scientific Publishing Co. Pte. Ltd.
Library of Congress subject classification: Q Science > QA Mathematics
Sets: Departments > Mathematics
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Date Deposited: 23 Jan 2012 15:23
URL: http://eprints.lse.ac.uk/41650/

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