Uncertainty and Investment Dynamics

44 Pages Posted: 14 Sep 2006 Last revised: 12 Jan 2014

See all articles by Nicholas Bloom

Nicholas Bloom

Stanford University - Department of Economics; 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)

Date Written: July 2006


This paper shows that, with (partial) irreversibility, higher uncertainty reduces the impact effect of demand shocks on investment. Uncertainty increases real option values making firms more cautious when investing or disinvesting. This is confirmed both numerically for a model with a rich mix of adjustment costs, time-varying uncertainty, and aggregation over investment decisions and time, and also empirically for a panel of manufacturing firms. These cautionary effects of uncertainty are large %u2013 going from the lower quartile to the upper quartile of the uncertainty distribution typically halves the first year investment response to demand shocks. This implies the responsiveness of firms to any given policy stimulus may be much lower in periods of high uncertainty, such as after major shocks like OPEC I and 9/11.

Suggested Citation

Bloom, Nicholas and Bond, Stephen R. and Van Reenen, John Michael, Uncertainty and Investment Dynamics (July 2006). NBER Working Paper No. w12383. Available at SSRN: https://ssrn.com/abstract=921549

Nicholas Bloom (Contact Author)

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John Michael Van Reenen

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Stanford Graduate School of Business ( email )

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