Contrasts Between Classes of Assets in Fixed Investment Equations as a Way of Testing Real Option Theory

Abstract

This paper tests the power of real options theory to explain investment under uncertainty, exploiting differences in the degree of irreversibility between machinery and buildings. It reports estimates of investment equations for each asset class using a large sample of UK manufacturing industries, with results that are consistent with the predictions of real options theory. Additionally, using a specially constructed industryspecific measure of irreversibility for machinery investment, the paper provides further confirmation of the empirical relevance of real options.Investment, Irreversibility, Real Options, Uncertainty, Panel Data