Time-to-build and capacity choice

This paper studies how demand uncertainty and time-to-build interact in affecting irreversible investment activity. Using impulse control methods we find the optimal timing and size of investment for a firm such as an electric utility that considers expanding its capacity in order to meet an uncertain demand. When the construction lag is short, uncertainty delays investment while increasing its size once it takes place. However, for comparatively long, and realistic, times-to-build the sensitivity to uncertainty is drastically reduced and the results can even be reversed; more uncertainty can speed up investment and reduce its size.