The Dynamics of Investment Under Uncertainty
Stanford University - Department of Economics; London School of Economics - Centre for Economic Performance (CEP); National Bureau of Economic Research (NBER)
Stephen R. Bond
Nuffield College; Institute for Fiscal Studies (IFS)
John Van Reenen
London School of Economics - Centre for Economic Performance (CEP); Stanford Graduate School of Business; Institute for Fiscal Studies (IFS); Centre for Economic Policy Research (CEPR)
IFS Working Paper No. W01/05
We derive robust predictions on the effects of uncertainty on short run investment dynamics in a broad class of models with (partial) irreversibility. When their environment becomes more uncertain firms become more cautious and less responsive to demand shocks. This result contrasts with the long run analysis, in which the effect of real options on the level of the capital stock is ambiguous. An investment model is estimated to test these theoretical predictions using a panel of UK firms and a stock returns-based measure of uncertainty. As predicted we find that uncertainty reduces firms' responsiveness to demand shocks.
Number of Pages in PDF File: 57
Keywords: Investment, uncertainty, real options, panel data
JEL Classification: D92, E22, D8, C23
Date posted: March 21, 2001
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