INVESTMENT, CONFIDENCE, AND LINEAR-EXPONENTIAL-GAUSSIAN CONTROL

Confidence was recognized as an important component of the investment decision by Keynes in his General Theory (1935). Over time, rational e xpectations and highly mathematical, dynamic optimization models have driven such notions from the investment literature. However, careful s pecification of a formal, dynamic optimization problem allows the 'sta te of confidence' to be reincorporated without violating the rational expectations hypothesis. A simple model of the firm is employed to est ablish approximate bounds on the potential impact of confidence on inv estment. The relative importance of confidence is shown to be determin ed largely by the levels of adjustment costs and demand uncertainty pr esent.