The Dynamics of Investment Under Uncertainty
IFS Working Paper No. W01/05
57 Pages Posted: 21 Mar 2001
Date Written: February 2001
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.
Keywords: Investment, uncertainty, real options, panel data
JEL Classification: D92, E22, D8, C23
Suggested Citation: Suggested Citation