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The Q theory of investment: does uncertainty matter

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  • Hong Bo

    (Groningen University)

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Abstract

This paper includes uncertainty in the Q-model of investment. A structural Q-type investment model is derived, which contains the information on uncertainty effects of random variables that affect the future profitability of a firm. We use a panel of 82 Dutch firms to test whether the presence of uncertainty affects the performance of the Q-model. Our evidence shows that the volatility of profits and the volatility of the interest rate influence investment apart from Q. Moreover, the presence of uncertainty factors changes the structural parameters of the Q-model of investment. The results suggest that the unsatisfactory empirical performance of the standard Q-model of investment may be due to the omission of uncertainty considerations. In addition, Dutch firm-level evidence shows that severe uncertainty effects are associated with small firms and highly indebted firms, which are more likely to be in financial distress. This provides indirect evidence that the wedge between external financing and internal financing aggravates the effect of uncertainty on investment.

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File URL: http://irs.ub.rug.nl/ppn/182938891
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Bibliographic Info

Paper provided by University of Groningen, Research Institute SOM (Systems, Organisations and Management) in its series Research Report with number 99E07.

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Date of creation: 1999
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Handle: RePEc:dgr:rugsom:99e07

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  1. Andrew B. Abel & Janice C. Eberly, 1993. "A Unified Model of Investment Under Uncertainty," NBER Working Papers 4296, National Bureau of Economic Research, Inc.
  2. Aizenman, Joshua & Marion, Nancy P. & Marion, Nancy P., 1993. "Macroeconomic uncertainty and private investment," Economics Letters, Elsevier, vol. 41(2), pages 207-210.
  3. Andrew B. Abel & Olivier J. Blanchard, 1983. "The Present Value of Profits and Cyclical Movements in Investment," NBER Working Papers 1122, National Bureau of Economic Research, Inc.
  4. Robert S. Chirinko, 1986. "Investment, Tobin's Q, and Multiple Capital Inputs," NBER Working Papers 2033, National Bureau of Economic Research, Inc.
  5. Schaller, Huntley, 1990. "A Re-examination of the Q Theory of Investment Using U.S. Firm Data," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 5(4), pages 309-25, Oct.-Dec..
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Cited by:
  1. Mellati, Ali, 2008. "Uncertainty and investment in private sector: An analytical argument and a review of the economy of Iran," MPRA Paper 26655, University Library of Munich, Germany.

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