Investment under uncertainty in equilibrium

This dissertation considers the investment behavior of firms in equilibrium. Two overarching themes unify the three papers within. The first theme is the role of real options in agents' investment decisions. That is, the value of the flexibility to defer real investment decisions. The second theme is the interaction of micro and macro economics. Agents make investment decisions at least partly based on macroeconomic conditions, but in equilibrium these optimal microeconomic choices aggregate to determine, in large part, the macroeconomic conditions on which they were based.; The first paper, An Equilibrium Model of Investment Under Uncertainty , analyzes the optimal investment decisions of heterogeneous firms in a competitive, uncertain environment. We characterize firms' optimal investment strategy explicitly, and derive a closed form solution for firm value. We show that in the strategic equilibrium real option premia are significant. As a result firms delay investment, choosing optimally not to undertake some positive NPV projects. The model predicts that firm returns vary over the business cycle, with returns negatively skewed during expansions but positively skewed in recessions.; The second paper, Irreversible Investment and the Business Cycle: Macroeconomic Implications of Optimal Microeconomic Behavior, introduces a preference based general equilibrium model with two consumption goods. The paper determines, as part of a strategic equilibrium, the optimal investment policy of heterogeneous firms that can develop additional capacity by incurring direct investment costs as well as an adjustment or opportunity cost. We value firms explicitly and analytically characterize the equilibrium strategy under which agents optimally deviate from the neoclassical zero NPV rule. Our results allow us to consider the macroeconomic effects of optimal microeconomic investment behavior. In particular, we consider how irreversibility in one sector of the economy affects the risk free interest rate, and the excess return demanded by investors to hold risky assets, in equilibrium. Finally, we consider the impact of business cycle movements on the yield curve and expected excess returns to risky assets.; The last paper, The Micro-Foundations of Hot and Cold Markets , offers an explanation for why housing market conditions, including transaction prices, average time to sale, and the relative number of buyers and sellers, are highly sensitive to demand shocks. High sensitivities result from interactions between macro-level housing market conditions and the microeconomic decision making process of participants in the market. Exogenous demand shocks at the macro level are amplified by market participants' optimal response to the shocks. For example, a positive demand shock such as an increase in income levels, or an increase in the rate at which people move to a city, results in more buyers, improving the bargaining position of the sellers, who then sell their properties more quickly. This results in a decrease in the housing stock on the market, further increasing the relative number of buyers to sellers, amplifying the initial shock.