Optimal investment under ambiguous technology shocks

Abstract

This paper analyzes the behavior of a firm facing an ambiguous technology shock and the effects of the attitude toward ambiguity on optimal capital investment using the smooth ambiguity model of Klibanoff et al. (2005). Although it seems intuitive that an increase in ambiguity aversion always reduces the optimal capital investment, this is not necessarily true because the shape of the production function plays a key role in determining the effect. Under some conditions, we show that the optimal amount of capital investment increases (decreases) in ambiguity aversion if the production function is substitute (complement), and that this result is counterintuitive when the production function is substitute. Furthermore, our main results hold if we assume the α-maxmin preferences in Ghirardato et al. (2004).