Optimal Investment Strategies under Decision-Dependent Stochastic Environments
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This thesis investigates the optimal investment decisions of a firm, when the characteristics of the firm's stochastic environment are dependent on these decisions. We model situations where the market the firm operates in responds to the investment conducted by the firm, and therewith affects the characteristics of the firm's stochastic profit flow. The thesis is comprised of two papers, which focus on different specifications of such investment problems. The first paper considers the case where a firm has the opportunity to enter a novel market. Prior to that it has the possibility to undertake a revenue-enhancing pre-investment. We find that there is an incentive for the firm to invest in two discrete steps, undertaking the revenue-enhancement before the investment to enter the market. We find that the relationship between uncertainty and investment timing can be ambiguous. Increased uncertainty can both delay or accelerate the investment decision for the revenue-enhancing activity. This is due to two counteracting effects of uncertainty. On the one hand, higher uncertainty increases the value of waiting to invest, which delays investment. On the other hand, it increases the value of the embedded option, which accelerates the investment. Which effect dominates is dependent on the cost parameters, the parameters for the economic environment, and the degree to which the firm can affect the stochastic environment through its revenue-enhancing activity. The second paper considers a firm who is currently operating in a market with an established product. It has a one-time opportunity to introduce a novel product, and therewith switch to a new product market. The profits of the new product have a different growth rate and are exposed to a different volatility than that of the initial product. Thus, investing to bring the new product to market changes the characteristics of the firm's stochastic environment. We find that the existence of a optimal finite investment threshold is dependent on the interplay of the relative change in growth and volatility for the two products. Further, the effect of the uncertainty of the initial product on the optimal investment strategy is ambiguous, and depending on two contradicting effects. Increasing the pre-investment volatility increases the option value of waiting, which delays investment. However, this also increases the relative attractiveness of the second product compared to the first product, which therefore accelerates investment. Lastly, we show that the problem of a one-time investment opportunity with changing characteristics of the stochastic environment and constant profit function, is equivalent to a problem of changing profit function and constant characteristics of the environment.