Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics

53 Pages Posted: 20 Jan 2007 Last revised: 8 Aug 2010

See all articles by Aubhik Khan

Aubhik Khan

Ohio State University (OSU)

Julia K. Thomas

Ohio State University

Multiple version iconThere are 2 versions of this paper

Date Written: January 2007

Abstract

We study a model of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity, and nonconvex adjustment costs lead them to pursue generalized (S,s) investment rules. We allow persistent heterogeneity in both capital and total factor productivity alongside low-level investments exempt from adjustment costs to develop the first model consistent with available evidence on establishment-level investment rates. Examining the implications of lumpy investment for aggregate dynamics in this setting, we find that they remain substantial when factor supply considerations are ignored, but are quantitatively irrelevant in general equilibrium. The substantial implications of general equilibrium extend beyond the dynamics of aggregate series. While the presence of idiosyncratic shocks makes the time-averaged distribution of plant-level investment rates largely invariant to market-clearing movements in real wages and interest rates, we show that the dynamics of plants' investments differ sharply in their presence. Thus, model-based estimations of capital adjustment costs involving panel data may be quite sensitive to the assumption about equilibrium. Our analysis also offers new insights about how nonconvex adjustment costs influence investment at the plant. When establishments face idiosyncratic productivity shocks consistent with existing estimates, we find that nonconvex costs do not cause lumpy investments, but act to eliminate them.

Suggested Citation

Khan, Aubhik and Thomas, Julia Kathryn, Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics (January 2007). NBER Working Paper No. w12845, Available at SSRN: https://ssrn.com/abstract=958497

Aubhik Khan (Contact Author)

Ohio State University (OSU) ( email )

2120 Fyffe Road
Columbus, OH OH 43210
United States

Julia Kathryn Thomas

Ohio State University

410 Arps Hall
1945 N. High St.
Columbus, OH 43210
United States

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