Investment Timing and Technological Breakthroughs

We study the optimal investment policy of a firm facing both technological and cash-flow uncertainty. At any point in time, the firm can irreversibly invest in a standalone technology or wait for a technological breakthrough. Breakthroughs occur when market conditions become favorable enough, exceeding a threshold value that is ex ante unknown to the firm. The Markov state variables for the optimal investment policy are the current market conditions and their historic maximum, and the firm optimally invests in the stand-alone technology only when market conditions deteriorate enough after reaching a maximum. The path-dependent return required for investing in the stand-alone technology is always higher than if no technological breakthroughs could occur and can take arbitrarily large values following certain histories. Decreases in development costs or increases in the value of the new technology make the firm more prone to bearing downside risk and delaying investment in the stand-alone technology.