Trends, Investment Behaviour and Policy Design
Edited by Raymond J.G.M. Florax, Henri L.F. de Groot and Peter Mulder
Chapter 8: The Effects of Uncertainty on Investments: Analysing the Environmental Impact of Energy Market Liberalization
Daan P. van Soest and Henri L.F. de Groot 1 INTRODUCTION One of the main factors affecting an entrepreneur’s decision to invest in new, energy-saving technologies is uncertainty about future government policies, changes in energy prices, and the arrival of new technologies. Indeed, accounting for uncertainty about the future has been found to contribute substantially to explaining variation in the intensity and timing of investments (see Chapter 7). In this chapter, we empirically test the validity of the predictions of one specific model of investment behaviour. The model was developed by Dixit and Pindyck (1994) and emphasizes the combined importance of uncertainty and irreversibility of investment decisions. Given the dynamic characteristics of investments, uncertainty about future prices can have an important (additional) impact on the decision whether or not to invest. Higher uncertainty may induce firms to postpone the decision to invest, awaiting the arrival of new information. Thus, firms mitigate the likelihood of investing in a project that ex post turns out to be unprofitable due to fallen (relative) prices of inputs. Entrepreneurs’ propensity to postpone is higher the larger the (sunk) cost involved when investing, the higher the uncertainty they face, and the higher the degree of persistence in the uncertain variable.1 In this chapter, we investigate the quantitative importance of such predictions by assessing the impact of the liberalization of natural gas markets in the USA on investments in energy-saving technologies. More specifically, we look at a special case of an energy-saving technology in the paper production...
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