Optimal Scrapping and Technology Adoption under Uncertainty

A firm has to decide sequentially to replace its technology and to implement a new one chosen among an increasing range over time under technological and market uncertainty. The optimal decision rule is a (s, S) style policy where the trigger and target technology levels are positively correlated with boom persistence and negatively related with recession persistence and technological uncertainty. The average time between two adoptions is governed by several factors. Bounded technological progress imposes a limitation on the best grade available, which can accelerate updating when the firm wishes to continue to operate an advanced technology. Technological uncertainty reinforces depreciation and thus hastens replacement. Moreover, both types of uncertainty have an impact on the scrapping and upgrading levels. Overall, adoption is more frequent for economies spending a large fraction of time in booms. The likelihood of switching during a recession is negatively affected by the arrival rate of booms. The end of a recession can trigger updating since the firm will want to operate an efficient technology in order to seize the high cash flows associated with the forthcoming boom. This result implies that investment spikes are procyclical. JEL Classification: D81, D92, O33