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Uncertainty, Investment, and Industry Evolution

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  • Caballero, Ricardo J
  • Pindyck, Robert S

Abstract

The authors study the effects of industrywide and idiosyncratic uncertainty on the entry of firms, total investment, and prices in a competitive industry with irreversible investment. They determine entry decisions and the resulting industry equilibrium and its characteristics, emphasizing effects of different sources of uncertainty. The authors stress how irreversibility affects the equilibrium distribution of prices, which in turn affects entry. Finally, they use four-digit U.S. manufacturing data to measure the extent of uncertainty and gauge its importance for investment. The authors find that a doubling of industrywide uncertainty raises the required rate of return on new capital by about 20 percent. Copyright 1996 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

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Bibliographic Info

Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 37 (1996)
Issue (Month): 3 (August)
Pages: 641-62

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Handle: RePEc:ier:iecrev:v:37:y:1996:i:3:p:641-62

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References

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  1. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-85, December.
  2. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
  3. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
  4. Pindyck, Robert S., 1990. "Irreversibility, uncertainty, and investment," Working papers 3137-90., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  5. Dixit, A., 1988. "Entry And Exit Decisions Under Uncertainty," Papers 91, Princeton, Department of Economics - Financial Research Center.
  6. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
  7. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  8. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Wiley Blackwell, vol. 61(2), pages 223-46, April.
  9. Bernanke, Ben S, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, MIT Press, vol. 98(1), pages 85-106, February.
  10. repec:fth:coluec:432 is not listed on IDEAS
  11. Dixit, Avinash K, 1989. "Hysteresis, Import Penetration, and Exchange Rate Pass-Through," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 205-28, May.
  12. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc.
  13. Leahy, J.V., 1991. "The Optimality of Myopic Behaviour in a Competitive Model of Entry and Exit," Harvard Institute of Economic Research Working Papers 1566, Harvard - Institute of Economic Research.
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