The Impact of Uncertainty on Investment: Empirical Challenges and a New Estimator
72 Pages Posted: 15 Jun 2021 Last revised: 5 Oct 2021
Date Written: June 13, 2021
This paper proposes a new method for examining the impact on a firm’s investment of uncertainty reflected in its stock-return volatility. We simultaneously address the endogeneity of uncertainty and mismeasurement in Tobin’s q, but earlier empirical work often neglects one of the two issues. Our nonparametric estimates further suggest that the relation between investment and uncertainty is significantly decreasing and strongly concave. This result contrasts with the existing literature that widely adopts linear regressions. Ignoring nonlinearity or measurement error in q can lead to a substantial estimation bias. However, the bias due to the endogeneity of uncertainty is small.
Keywords: endogeneity, investment, measurement error, series approximation, Tobin’s q, uncertainty
JEL Classification: C14, E22, G31
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