Costly Reversible Investment With Fixed Costs

Abstract

The analysis presented here applies a generalized version of the friction model to costly reversible investment with fixed costs of investment. The analysis investigates three U.S. industries: the computer and office equipment industry, the automobile industry, and the airline industry. Five different investment models are compared. Because some models are nonnested, the analysis employs Vuong's test of model selection. The analysis shows that the investment model with costly reversibility and fixed costs is the best among the models. In addition, the analysis suggests the existence of convex adjustment costs of investment.