Wright meets Markowitz: How standard portfolio theory changes when assets are technologies following experience curves

Preprint English OPEN
Way, Rupert ; Lafond, François ; Lillo, Fabrizio ; Panchenko, Valentyn ; Farmer, J. Doyne (2017)
  • Subject: Economics - General Economics

We consider how to optimally allocate investments in a portfolio of competing technologies using the standard mean-variance framework of portfolio theory. We assume that technologies follow the empirically observed relationship known as Wright's law, also called a "learning curve" or "experience curve", which postulates that costs drop as cumulative production increases. This introduces a positive feedback between cost and investment that complicates the portfolio problem, leading to multiple local optima, and causing a trade-off between concentrating investments in one project to spur rapid progress vs. diversifying over many projects to hedge against failure. We study the two-technology case and characterize the optimal diversification in terms of progress rates, variability, initial costs, initial experience, risk aversion, discount rate and total demand. The efficient frontier framework is used to visualize technology portfolios and show how feedback results in nonlinear distortions of the feasible set. For the two-period case, in which learning and uncertainty interact with discounting, we compare different scenarios and find that the discount rate plays a critical role.
  • References (37)
    37 references, page 1 of 4

    Alberth, S. & Hope, C. (2007), 'Climate modelling with endogenous technical change: Stochastic learning and optimal greenhouse gas abatement in the page2002 model', Energy Policy 35(3), 1795-1807.

    Alchian, A. (1963), 'Reliability of progress curves in airframe production', Econometrica 31(4), 679-693.

    Almgren, R. & Chriss, N. (2001), 'Optimal execution of portfolio transactions', Journal of Risk 3, 5-40.

    Arrow, K. J. (1962), 'The economic implications of learning by doing', The Review of Economic Studies pp. 155-173.

    Arthur, W. B. (1989), 'Competing technologies, increasing returns, and lock-in by historical events', The Economic Journal pp. 116-131.

    Atkinson, A. B. & Stiglitz, J. E. (1969), 'A new view of technological change', The Economic Journal 79(315), 573-578.

    Barreto, L. & Kypreos, S. (2004), 'Endogenizing r&d and market experience in the “bottom-up” energy-systems eris model', Technovation 24(8), 615-629.

    Boyle, P., Garlappi, L., Uppal, R. & Wang, T. (2012), 'Keynes meets markowitz: The trade-off between familiarity and diversification', Management Science 58(2), 253-272.

    Brueckner, J. K. & Raymon, N. (1983), 'Optimal production with learning by doing', Journal of Economic Dynamics and Control 6, 127-135.

    Cabral, L. M. & Riordan, M. H. (1994), 'The learning curve, market dominance, and predatory pricing', Econometrica: Journal of the Econometric Society pp. 1115- 1140.

  • Related Research Results (1)
  • Metrics
    No metrics available
Share - Bookmark