Investment decisions with finite-lived collars

Research output: Contribution to journalArticle

  • Authors:
  • Roger Adkins
  • Dean Paxson
  • Paulo J. Pereira
  • Artur Rodrigues

Abstract

The duration of most collar arrangements provided by governments to encourage early investment in infrastructure, renewable energy facilities, or other projects with social objectives are finite, not perpetual. We extend the previous literature on collar-style arrangements by providing an analytical solution for the idle and active values, as well as the investment triggers, for projects where collars are either finite-lived or retractable. What is the difference between these types of arrangements with their perpetual counterpart? Lots, including different vega signs, and substantially different values for different current price levels. Often, finite and retractable collars justify earlier investment timing than perpetual collars. In general, we demonstrate that the finite-lived and retractable versions have a significant impact on optimal behavior, relative to the perpetual case. An important consideration when negotiating the floors, ceilings, and duration (or signalling the expected duration) of a finite or a retractable collar is the current price level of the output and its expected volatility over the life of the contract.

Bibliographical metadata

Original languageEnglish
Pages (from-to)185-204
Number of pages20
JournalJournal of Economic Dynamics and Control
Volume103
Early online date28 Apr 2019
DOIs
Publication statusPublished - 1 Jun 2019