CAPACITY CHOICE AS THE EXERCISE OF A FINA NCIAL CALL OPTION

This paper is one of the first attempts to verify the validity of opti on theory, as applied to real investment, by confronting the theory wi th empirical observations. We use capacity investments by Canadian cop per mines. One major difficulty in transposing the financial theory of options to real investment is the fact that real investments and, mor e generally, several characteristics of the projects, depend in genera l on the date at which the investment is undertaken. We have partially endogenized these elements using econometric results relating capacit y decisions with a number of time-dependent explanatory variables. Und er a number of simplifying assumptions, we were then able, using the o ption pricing model, to compare the value of investment projects in th e periods preceding their effective realization with the trigger value above which theory called for the project to go ahead. We have found that the firms in our sample acted in conformity with option theory in 60 per cent of the cases. This figure rises to 80 per cent (90 per ce nt) if we consider cases where investment actually occurred within one (two) year(s) of the date predicted by the theory. While we do not of fer any statistical test of the validity of the theory, these results appear to speak in its favour.