The Interaction between Firms and Government in the context of Investment Decisions: A Real Options Approach

Barbosa, Diogo; Carvalho, Vitor M.; Pereira, Paulo J.
October 2013
Working Papers (FEP) -- Universidade do Porto;Oct2013, Issue 507, preceding p1
Working Paper
Given the global financial crisis and, particularly, the European sovereign-debt crisis, European countries have the urgent need to promote output growth. However, due to the current financial constraints, it is difficult for the Governments to stimulate economic growth by directly increasing investment. Alternatively, they can promote private investment, either by reducing the uncertainty and costs, or by directly subsidizing those investments. In this paper we try to analyze alternative solutions to promote investment, and hence economic growth, under a context of Government austerity. We develop a real options model in order to study optimal investment decisions, considering both the point of view of firms and Government. So, we incorporate the Government in the baseline real options model, and we use this extended model to drive the optimal behavior for firms and Government on their decision to invest and promote investment, respectively. To be more realistic, the model takes into account, not only inefficiencies (both concerning the implementation and management of the project), but also the economic benefits of investing, i.e., the investment multiplier effect in the economy. We also make a sensitivity analysis for the key parameters and define regions for different types of investment. Alternative solutions are also considered. Among the main conclusions we find that the probability of being optimal for the Government to subsidize private investment rather than investing directly is greater the larger the private investment multiplier effect, the tax rates, the private present value of the profit flows, the private cost of the investment and, also, the inefficiency level of the Government.


Related Articles

  • Why 'Fiscal Austerity'? A Review of Recent Evidence on the Economic Effects of Sovereign Debt. Bonser-Neal, Catherine // Indiana Journal of Global Legal Studies;Summer2015, Vol. 22 Issue 2, p543 

    Concerns about the economic effect of high sovereign debt levels have motivated policy makers to constrain or reduce the growth of fiscal deficits, a practice commonly known now as 'fiscal austerity.' However, what do we know about the economic impacts of sovereign debt? This article provides an...

  • 2008 EUROPEAN DEBT CRISIS AND ITS POSSIBLE IMPLICATIONS ON THE ECONOMIES OF DEVELOPING COUNTRIES: TURKEY CASE. Topkaya, Özgür; Özekicioğlu, Halil; Özel, Hasan Alp // Ataturk University Journal of Economics & Administrative Science;2013, Vol. 27 Issue 4, p303 

    2008 economic crisis would have several implications on developing countries since developing countries have several inadequacies in relation to institutional adjusments for regulation of their financial markets in european economies. These inadequacies cause important problems in their markets....

  • Which country's word is its bond?  // Fund Strategy;5/7/2012, p1 

    The article focuses on the credit crises in developed countries, particularly in reference to Europe's sovereign debt crises. It mentions that the financial crisis and resultant damage of public finances across the developed nations have given rise to new investment risks into government bond...

  • Talking to Europe. Reeves, Rachel // Prospect;Feb2012, Issue 191, p17 

    The article presents the author's views on the financial crisis in Europe. She says that European countries are struggling to deal with slowing economy, however imposing punitive austerity measures and prolonged recession will not help them. According to her, the actual problem of Europe is its...

  • Chapter 6: BMI Global Assumptions.  // East Caribbean Business Forecast Report;2012 2nd Quarter, Issue 2, p57 

    The article forecasts global growth, in which it is stated that growth has declined since the beginning of 2012, as the eurozone crisis simmering, China's external sector is hit by a slowdown in global demand, and many emerging market economies still expanding.

  • A Passion for Job Insecurity. Ackerman, Seth // Extra!;Feb2013, Vol. 26 Issue 2, p7 

    The article focuses on the mass media coverage of the Eurozone economic crisis, which seem obsessed reporters and pundits in the U.S. It discusses the debates surrounding austerity and its impact on economic growth and debt reduction, wherein, policymakers and pundits urge cuts to social...

  • The Current Economic Crisis of the EU: Genesis, Analysis and Solutions. Troitiño, David Ramiro // Baltic Journal of European Studies;Jun2013, Vol. 3 Issue 1, p6 

    The article approaches the current economic crisis from an historical perspective, analyzing the building of the monetary integration and the common currency. The process is explained through pointing out its effects on the European integration and outlining the positive and negative...

  • Europeans Fight Back. Pal, Amitabh // Progressive;Sep2012, Vol. 76 Issue 9, p8 

    The article discusses how wrong policies of policymakers in European countries resulted in financial and debt crises in the region, and the efforts of people to organize protests against austerity in Europe. It is said that due to faulty construction of euro, countries like Greece and Spain were...

  • Debt Most Deadly. Nadeau, Barbie Latza // Newsweek (Pacific Edition);6/25/2012 (Pacific Edition), Vol. 159 Issue 26, p8 

    The article explores the increasing incidences of suicides in Europe caused by the economic crisis. Since the beginning of 2012, 80 Italians were reported to have committed suicides linked to austerity measures. Similarly, many more have killed themselves in Greece following the financial...


Read the Article


Sorry, but this item is not currently available from your library.

Try another library?
Sign out of this library

Other Topics