Advanced Search
MyIDEAS: Login to save this paper or follow this series

Uncertainty and Investment Dynamics

Contents:

Author Info

  • Nick Bloom
  • Stephen Bond
  • John Van Reenen

Abstract

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 - 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.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://cep.lse.ac.uk/pubs/download/dp0739.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0739.

as in new window
Length:
Date of creation: Aug 2006
Date of revision:
Handle: RePEc:cep:cepdps:dp0739

Contact details of provider:
Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

Related research

Keywords: Investment; uncertainty; real options; panel data;

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Luigi Guiso & Giuseppe Parigi, 1999. "Investment And Demand Uncertainty," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 114(1), pages 185-227, February.
  2. Ricardo J. Caballero & Eduardo M.R.A. Engel, 1994. "Explaining Investment Dynamics in U.S. Manufacturing: A Generalized (S,s) Approach," NBER Working Papers 4887, National Bureau of Economic Research, Inc.
  3. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, Elsevier, vol. 87(1), pages 115-143, August.
  4. Jacques Mairesse & Bronwyn H. Hall & Benoit Mulkay, 1999. "Firm-Level Investment in France and the United States: An Exploration of What We Have Learned in Twenty Years," NBER Working Papers 7437, National Bureau of Economic Research, Inc.
  5. Russell Cooper & Joao Ejarque, 2003. "Financial Frictions and Investment: Requiem in Q," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 710-728, October.
  6. John V. Leahy & Toni M. Whited, 1995. "The Effect of Uncertainty on Investment: Some Stylized Facts," NBER Working Papers 4986, National Bureau of Economic Research, Inc.
  7. Mark Doms & Timothy Dunne, 1994. "Capital Adjustment Patterns in Manufacturing Plants," Working Papers 94-11, Center for Economic Studies, U.S. Census Bureau.
  8. Caballero, R.J., 1996. "Fixed Costs: The Demise of Marginal q," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 96-14, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc.
  10. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  11. Stephen Bond & Alexander Klemm & Rain Newton-Smith & Murtaza Syed & Gertjan Vlieghe, 2004. "The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment," Bank of England working papers, Bank of England 222, Bank of England.
  12. Caballero, Ricardo J, 1991. "On the Sign of the Investment-Uncertainty Relationship," American Economic Review, American Economic Association, American Economic Association, vol. 81(1), pages 279-88, March.
  13. Abel, Andrew B. & Eberly, Janice C., 1999. "The effects of irreversibility and uncertainty on capital accumulation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 44(3), pages 339-377, December.
  14. Nick Bloom, 2006. "The impact of uncertainty shocks: firm level estimation and a 9/11 simulation," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 19867, London School of Economics and Political Science, LSE Library.
  15. John Y. Campbell, 2001. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 56(1), pages 1-43, 02.
  16. Abel, Andrew B & Eberly, Janice C, 1994. "A Unified Model of Investment under Uncertainty," American Economic Review, American Economic Association, American Economic Association, vol. 84(5), pages 1369-84, December.
  17. Stephen Bond & Dietmar Harhoff & John Van Reenen, 2003. "Investment, R&D and Financial Constraints in Britain and Germany," CEP Discussion Papers, Centre for Economic Performance, LSE dp0595, Centre for Economic Performance, LSE.
  18. Marcelo Veracierto, 1997. "Plant level irreversible investment and equilibrium business cycles," Discussion Paper / Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis 115, Federal Reserve Bank of Minneapolis.
  19. Nicholas Bloom, 2000. "The dynamic effects of real options and irreversibility on investment and labour demand," IFS Working Papers, Institute for Fiscal Studies W00/15, Institute for Fiscal Studies.
  20. Bloom, Nicholas & Bond, Stephen Roy & Van Reenen, John, 2003. "Uncertainty and Company Investment Dynamics: Empirical Evidence for UK Firms," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4025, C.E.P.R. Discussion Papers.
  21. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 61(2), pages 223-46, April.
  22. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, Elsevier, vol. 5(2), pages 258-266, October.
  23. Diego A. Comin & Thomas Philippon, 2006. "The Rise in Firm-Level Volatility: Causes and Consequences," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 167-228 National Bureau of Economic Research, Inc.
  24. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, Econometric Society, vol. 55(2), pages 251-76, March.
  25. Joanne M. Doyle & Toni M. Whited, 2001. "Fixed Costs Of Adjustment, Coordination, And Industry Investment," The Review of Economics and Statistics, MIT Press, vol. 83(4), pages 628-637, November.
  26. Andrew B. Abel & Janice C. Eberly, 1995. "Optimal Investment with Costly Reversibility," NBER Working Papers 5091, National Bureau of Economic Research, Inc.
  27. Eberly, Janice C. & Van Mieghem, Jan A., 1997. "Multi-factor Dynamic Investment under Uncertainty," Journal of Economic Theory, Elsevier, Elsevier, vol. 75(2), pages 345-387, August.
  28. Øivind Anti Nilsen & Fabio Schiantarelli, 2003. "Zeros and Lumps in Investment: Empirical Evidence on Irreversibilities and Nonconvexities," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 1021-1037, November.
  29. Steven Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 1987. "Financing Constraints and Corporate Investment," NBER Working Papers 2387, National Bureau of Economic Research, Inc.
  30. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, Elsevier, vol. 68(1), pages 29-51, July.
  31. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, American Economic Association, vol. 73(1), pages 228-33, March.
  32. Timothy Erickson & Toni M. Whited, 2000. "Measurement Error and the Relationship between Investment and q," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 108(5), pages 1027-1057, October.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:cep:cepdps:dp0739. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.