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Investment decisions with finite-lived collars
Adkins, Roger Paxson, D. Pereira, P.J. Rodrigues, A.
Adkins, Roger
Paxson, D.
Pereira, P.J.
Rodrigues, A.
Publication Date
2019-06
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© 2019 Elsevier B.V. All rights reserved. Reproduced in accordance with the publisher's self-archiving policy. This manuscript version is made available under the CC-BY-NC-ND 4.0 license.
Peer-Reviewed
Yes
Open Access status
openAccess
Accepted for publication
28/04/2019
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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.
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Accepted manuscript
Citation
Adkins R, Paxson D, Pereira PJ et al (2019) Investment decisions with finite-lived collars. Journal of Economic Dynamics and Control. 103: 185-204.
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Article